Pirelli & C. S.p.A. Milan Annual Report 2006 · Deputy Chairman 2 Carlo Alessandro Puri Negri Directors Carlo Acutis * Carlo Angelici *

Pirelli & C. S.p.A. Milan Annual Report 2006

Call to the Annual General Meeting of theShareholdersThe ordinary shareholders of Pirelli & C. Società per Azioni are called to the ordinary session of theshareholders’ meeting to be held in Milan, Viale Sarca 214,

- on Friday April 20, 2007 at 16:00 p.m. in first call;

- on Monday April 23, 2007 at 10:30 a.m. in second call,

to pass resolutions on the following

AGENDA

Ordinary Session

1. The financial statements at December 31, 2006; inherent and consequent resolutions.

2. Appointment of two Directors and/or reduction of Board of Directors members. Inherent andconsequent resolutions

3. Proposals of modifications of the Regulations for Shareholders’ Meetings adopted by theshareholder meeting held on May 11, 2004.

Extraordinary session

• Modifications to articles 5 (share capital), 6 (shareholders), 7 (shareholders meetings),8 (resolutory and final quorum), 9 (procedures for shareholders meetings), 10 (Companyadministration), 11 (functions of the Board of Directors), 12 (Board of Directors meetings),13 (representation of the company), 15 (expiry of the term of office of the Board of Directors) and16 (Board of Statutory Auditors) of the Company Bylaws.

Inherent and consequent resolutions. Conferring of powers.

1

A Call to the AGMContentsPirelli & C. S.p.A.Structure of Pirelli Groupat December 31, 2006Pirelli & C. S.p.A. on theStock MarketSelected Financial DataChairman’s Letter

Preliminary information Directors’ Report Consolidated Financial Statements Extraordinary Session Sustainability Report

ContentsPage

Preliminary information 1

Call to the Annual General Meeting of the Shareholders 1Pirelli & C. S.p.A. 3Structure of Pirelli Group at December 31, 2006 4Pirelli & C. S.p.A. on the Stock Market 4Five-Year Summary of Selected Consolidated Financial Data 5Chairman’s letter 6

Directors’ report on operations 9

The Group 11Pirelli Tyre 34Pirelli Broadband Solutions 44Pirelli & C. Real Estate 47Pirelli & C. Ambiente 51Information systems 53Proforma data 57Equity Investments held by Directors, Statutory Auditors and General Managers 59Stock option plans 59Corporate Governance 60Pirelli & C. S.p.A. - Summary Data 95Shareholders’ Resolutions 99

Consolidated financial statements at December 31, 2006 107

Consolidated balance sheet 108Consolidated income statement 109Consolidated statement of changes in shareholders’ equity 110Consolidated statement of cash flows 111Notes to the consolidated financial statements 112Independent Auditor’s Report 186

Extraordinary session 188

Sustainability Report 207

Pirelli and sustainable development 208Economic dimension 218Environmental dimension 229Social dimension 267Summary tables 303

2

Call to the AGMA Contents

Pirelli & C. S.p.A.Structure of Pirelli Groupat December 31, 2006Pirelli & C. S.p.A. on theStock MarketSelected Financial DataChairman’s Letter


Pirelli & C. S.p.A.Board of Directors 1

Chairman 2 Marco Tronchetti Provera

Deputy Chairman 2 Alberto PirelliDeputy Chairman 2 Carlo Alessandro Puri Negri

Directors Carlo Acutis *Carlo Angelici * °Gilberto BenettonAlberto Bombassei *Franco Bruni * °Gabriele Galateri di GenolaMario Garraffo *Dino Piero Giarda *Berardino Libonati * ¨

Giulia Maria LigrestiMassimo MorattiGiovanni PerissinottoGiampiero Pesenti * ¨

Aldo Roveri * ¨

Carlo Secchi * °Paolo Vagnone

* Independent director° Member of the Internal Control and Corporate Governance Committee¨ Member of the Remuneration Committee

Secretary to the Board Anna Chiara Svelto

Board of Statutory Auditors 3

Chairman Luigi GuatriStanding members Enrico Laghi

Paolo Francesco LazzatiAlternate members Franco Ghiringhelli

Luigi Guerra

General Managers 4

Operations Claudio De ContoFinance and Strategic Planning Luciano Gobbi

Independent Auditors 5

PricewaterhouseCoopers S.p.A.

1 Appointment: April 28, 2005. Expiry: shareholders’ meeting called to approve the financial statements at December 31, 2007.Alberto Bombassei was co-opted by the board of directors’ meeting held on September 12, 2006. On November 6, 2006, Carlo Buora tenderedhis resignation from the posts held in the company

2 Office conferred by the board of directors’ meeting held on April 28, 2005.3 Appointment: April 21, 2006. Expiry: shareholders’ meeting called to approve the financial statements at December 31, 2008.4 Francesco Gori was General Manager of Tyres Sector until June 30, 2006. Starting July 1, 2006 he is Managing Director and General Manager of

Pirelli Tyre S.p.A..5 Appointment conferred by the shareholders’ meeting held on April 28, 2005.

3

Call to the AGMContents

A Pirelli & C. S.p.A.Structure of Pirelli Groupat December 31, 2006Pirelli & C. S.p.A. on theStock MarketSelected Financial DataChairman’s Letter


Structure of Pirelli Group at December 31, 2006

4

Call to the AGMContentsPirelli & C. S.p.A.

A Structure of Pirelli Groupat December 31, 2006

A Pirelli & C. S.p.A. on theStock MarketSelected Financial DataChairman’s Letter


Pirelli & C. S.p.A. on the Stock Market

Pirelli & C. S.p.A. share capital movements since December 31, 2002

Number of shares outstandingat December 31, 2006 at April 20, 2007

Pirelli & C. S.p.A. - Ordinary shares 5,233,142,003 5,233,142,003

Pirelli & C. S.p.A. - Savings shares 134,764,429 134,764,429

Market Trading on the Milan Stock ExchangeShares traded Amount

Volume (in millions of euros)

Pirelli & C. - Ordinary shares 8,861,567,702 6,576

Pirelli & C. - Savings shares 115,895,385 82

Date Capital (thousands) Transactions

December 2002 Euros 339,423 bond conversion

May 2003 Euros 272,083 exercise of the right of share withdrawal following the changein the company type and the corporate business purpose

June 2003 Euros 1,084,247 issue of shares cum warrants (1 warrant : 1 share) with rightsoffering (3 ordinary shares : 1 share of any class) at € 0.52

August 2003 Euros 1,799,400 share capital increase as a result of the merger by exchange

December 2004 Euros 1,800,383 warrant conversion

February 2005 Euros 1,974,633 warrant conversion

March 2005 Euros 2,763,953 issue of shares with rights offering (2 ordinary shares:5 shares of any class) at € 0.70

December 2005 Euros 2,764,057 warrant conversion

April 2006 Euros 2,764,716 warrant conversion

June 2006 Euros 2,791,311 warrant conversion

5

Call to the AGMContentsPirelli & C. S.p.A.Structure of Pirelli Groupat December 31, 2006Pirelli & C. S.p.A. on theStock Market

A Selected Financial DataChairman’s Letter


Five-Year Summary of Selected ConsolidatedFinancial Data

(IAS/IFRS) (Italian GAAP)in millions of euros 2006 2005 2004 2003 2002

Net sales 4,841 4,546 3,967 6,671 6,718 Gross operating profit 614 568 470 628 523 Operating profit 401 355 269 268 118 Operating profit (loss) incl. earnings (losses) from investments (748) 622 425 217 (57) Total income (loss) (1,049) 399 304 4 (405) Income (loss) attribut. to the equity holders of Pirelli & C. S.p.A. (1,167) 327 251 (39) (58) Earnings (losses) per share (in euros) (0.22) 0.07 0.07 (0.01) (0.09)

Fixed assets 6,924 7,629 6,097 5,902 6,596 Net working capital 463 (53) 466 566 991 Net invested capital 7,387 7,576 6,563 6,468 7,587 Equity 4,687 5,614 3,841 3,678 4,626 Provisions 720 785 1,121 1,045 911 Net financial (liquidity)/debt position 1,980 1,177 1,601 1,745 2,050 Equity attributable to the equity holders of Pirelli & C. S.p.A. 3,880 5,205 3,502 3,429 1,933 Equity per share (in euros) 0.72 0.98 1.01 0.99 2.96

Free cash flow 317 343 287 564 476 R&D expenditures 171 174 171 204 219 Depreciation 201 197 182 278 315 Capital expenditures 255 234 211 273 337

Gross operating profit / net sales 12.68% 12.49% 11.85% 9.41% 7.79% Operating profit / net sales - ros 8.28% 7.81% 6.78% 4.02% 1.76% Income / equity * - roe (20.37%) 7.38% 5.77% 0.10% (8.75%) Operating profit / net invested capital* - roi 5.36% 5.02% 4.13% 3.81% 1.56%Operating profit (post investments) / net invested capital * (10.00%) 8.80% 6.52% 3.09% (0.71%)Net financial position / equity 0.42 0.21 0.42 0.47 0.44 Capital expenditures / depreciation 1.27 1.19 1.16 0.98 1.07 R&D expenditures / net sales (industrial aggregate) 3.53% 3.83% 4.31% 3.38% 3.45% Net sales per employee (in thousands of euros) 172 173 162 182 174

Pirelli & C. S.p.A. ordinary shares (no. in millions) 5,233.1 5,180.7 3,327.5 3,325.6 618.2 Pirelli & C. S.p.A. savings shares (no. in millions) 134.8 134.8 134.8 134.8 34.4 Total Pirelli & C. S.p.A. shares (no. in millions) 5,367.9 5,315.5 3,462.3 3,460.4 652.6 Treasury shares (no. in millions) 2.6 2.6 2.6 2.6 2.6

Factories 24 24 74 77 79 of which discontinued operations 52Employees (at 12/31) 28,617 26,827 24,790 36,337 37,350 of which temporary employees 3,479 3,102 2,721 2,417 2,257

*Average amounts

Chairman’s letterTo the shareholders,2006 was a particularly demanding year for the Pirelli & C. Groupwhich dealt not only with the complexity of normal businessoperations but had to confront important challenges on the financialfront.From the standpoint of operations, the Group continued on the pathof growth begun in the last few years thanks to the goodperformance of all its activities, especially the Tyres and Real Estatesectors. In fact, the consolidated figures show that revenues grew by6.5 percent to nearly Euros 5 billion, with a gross operating marginof 8.2 percent, and operating income exceeded the threshold ofEuros 400 million, recording double-digit growth (+13.1 percent).These results confirm the excellent state of the health of the Group’sactivities and the validity of our strategy of focusing on sectors withgreater value-added and with a higher technological content.During the course of 2006, besides, the Group further expanded itspresence worldwide in the wake of a tradition that spans a centuryin which Pirelli is a protagonist of the competition in the majorinternational markets. As regards industrial activities, in particular,Pirelli Tyre commenced the production of high-performance tyres inRomania, inaugurated a new truck tyre production facility in Braziland consolidated its presence in China, where in the next fewmonths the current truck tyre factory will be joined by a new cartyre plant. But 2006 was also the year of the internationalization ofPirelli Real Estate, a protagonist in important deals in Poland andespecially in Germany where it concluded the agreement for theacquisition of DGAG, one of the foremost real estate companies inthe country with its main offices in Hamburg and Kiel.On the financial front, the first part of the year was the focus of theproject for the listing of Pirelli Tyre on the stock market. Theobjective of this operation was the further development of thecompany, which its launch on the market would have been anoptimal way for its intrinsic value to emerge. However, the difficultmarket conditions and, above all, the sharp drop in the marketprices of the major operators of the sector during the final stages ofthe process led us to choose to withdraw the offering last June 30.But the idea of listing Pirelli Tyre on the stock market was notabandoned. At the beginning of August, in fact, we signed anagreement with a syndicate of leading financial institutions for aprivate placement of 38.9 percent of the company, finalized with aview to a successive Initial Public Offering.Again on the financial side, we began a plan to dispose of non-strategic investments with the aim of focusing still further on thecore businesses of the Group. With regard to Olimpia, Pirelliincreased its investment in 2006, raising it from 57.66 percent to 80percent following the purchase of the stakes held by Hopa, BancaIntesa and UniCredit at the end of pre-existing shareholders’agreements. Nevertheless, the market performance of Telecom Italiashares, below the expectations of Pirelli’s management, and thereduction in the target price by analysts led to a decline in themarket value of that investment. As a consequence, at the board ofdirectors’ meeting, we decided to adjust the carrying amount.The amount of the adjustment in the consolidated financialstatements was equal to Euros 2,110 million and corresponds to thevalue assigned to Olimpia’s asset (the Telecom Italia shares) ofEuros 3 per share versus the previous value of about Euros 4 per

6

Call to the AGMContentsPirelli & C. S.p.A.Structure of Pirelli Groupat December 31, 2006Pirelli & C. S.p.A. on theStock MarketSelected Financial Data

A Chairman’s Letter


share. This transaction had an impact on the net result of Pirelliwhich, despite its good operating performance reported a loss ofEuros 1,048.8 million on consolidation and will not allow thecompany to pay out dividends for the year 2006. The adjustment ofthe value of the Telecom Italia investment in Olimpia, however, hadno repercussions on the soundness of the equity and financialposition of our company which, at the end of 2006, reportedconsolidated equity of Euros 4,686.6 million and net financial debt ofEuros 1,979.6 million, a figure in line with the forecasts announced tothe market. As for Olimpia, finally, the Pirelli board of directors’ meeting lastMarch 12 vested me with the power to explore all possible options,not excluding that of its total disposal, to achieve the best strategicvaluation of the asset in the interests of all the stakeholders.Moving on to the individual businesses, in tyres, Pirelli Tyre recorded anincrease in sales of nearly 9 percent and a growth in operating incomecompared to 2005, despite higher raw material costs which hurt the tyreindustry throughout the world. In an economic scenario that was notfavorable, the company managed to grow more than the average of themarket thanks to efficiencies and, above all, to the product mix, theoutgrowth of its positioning in the high range of the segments.The performance of the Consumer market (cars and motorcycle), inparticular, was excellent: strong gains were recorded in both sales andoperating income. Demand was particularly positive in Europe and inNorth America (even though the market in that area was negative),confirming Pirelli’s leadership in the high-performance, ultra-high-performance and Winter segments. In the Industrial market, in spite ofa general rise in demand which had a positive effect on sales,operating income is lower than in 2005 owing to the peak reached inthe price of natural rubber, the main raw material cost item of thesector. As for Pirelli’s international presence, the start of the new truckplant at Gravatai (Brazil) allowed the company to complete itsinvestment program in the Industrial segment with additionalproduction capacity and a better competitive position. In the secondhalf of the year, moreover, the new car tyre production facility cameon line at Slatina (Romania) and once fully operational will be able tomanufacture each year 4.5 million high-performance tyres slated forthe European market and employ about 1,000 people. The overallinvestment totals Euros 170 million and makes it possible to bring intobeing, together with the steelcord factory inaugurated in 2005, one ofthe most important industrial hubs of the company in the world.In real estate, Pirelli Real Estate recorded double-digit growth in themain economic indicators, in particular, in operating income includingthe earnings of investment holdings (+15 percent) which reached thetop range in the three year 2006-2008 business plan (CAGR 10-15percent). During 2006, the company consolidated its leadershipposition in Italy and, with Pirelli Pekao Real Estate in Poland andDGAG in Germany, accelerated the expansion process in Central-EastEurope. Asset management reached Euros 14.5 billion (14 percent ofwhich is outside Italy), with a growth of 12 percent compared to 2005.In March 2007, moreover, Pirelli Real Estate was awarded themanagement of the first private fund seeded by state-owned propertiesmanaged by the Sicily Region. The acquisition of Ingest Facility fromthe Fiat Group followed in the same month; this company has becomethe leader in the facility management sector in Italy and is nowbranching out to create a European pole.As for the start-ups, Pirelli Broadband Solutions reported a 15.3percent gain in sales, linked in part to a significant contribution bysecond-generation photonics, and achieved breakeven at the

7




operating level for the time since it was set up. After havingconsolidated the top position on the market in Italy, the company hascommenced the internationalization process, marketing its solutionsin Europe for broadband access (specifically residential gatewayaccesses and dual-mode telephones) and higher-margin photonicsproducts (components and optical modules for improving theperformance and the flexibility of telecommunications networks).Pirelli Ambiente, too, active in the sectors of the environment andsustainable development, reached an operating breakeven andconfirmed the growth trend in sales (+12.2 percent). In 2006,moreover, the company signed the lease contract for land in theRomanian county of Gorj on which a production facility will be builtfor anti-particulate filters for diesel vehicles destined for the originalequipment market in Europe.The growth of the results of the start-ups is also the outcome ofsynergies with Pirelli Labs, the center of technological excellence ofthe Group. In 2006, Pirelli Labs continued its research activities oninnovative materials and on optical technologies fortelecommunications, sectors in which it has also sealed two newpartnerships with the ENEA and the CNR Istituto sull’InquinamentoAtmosferico research centers. Besides collaborating with all thebusinesses of the Group, Pirelli Labs has also gone forward on thejoint research projects with important national and internationalcenters such as Politecnico di Milano University, Georgia Tech andthe Alberta Research Council.Pirelli’s commitment on the front of innovation is also confirmed bythe latest figures of the World Organization of Intellectual PropertyOrganization (Wipo), according to which in 2006 our company is inthe top three in Italy for international patent filings.For 2007, the strategy of focusing on segments with higher value-added and the good performance of the core businesses allow us toforecast a further improvement in results. This path on the road togrowth will thus continue thanks to the quality and the values whichhave always been the trademark of the Pirelli Group and its persons;orientation towards results, ability to innovate and compete oninternational markets, allegiance, correctness and transparency.Loyalty to values, in fact, has always been the inspiration behind allof the Group’s actions and this leads us to dedicate a section to theSustainability Report. Now in its second edition, the report aims tobe the full expression of the company culture founded on theintegration of economic choices with environmental and social ones,representing an indication of priorities and, at the same time, anencouragement to work for the satisfaction of all the stakeholders.It is to them that we wish to offer a description that is the most exactpossible of the activities of the Group, also from this particular pointof view. The promotion of a sustainable industrial growth isincreasingly appreciated by the financial markets and the ratingagencies and the whole of public opinion as an important elementin the evaluation of corporations, as a premise for healthy andlong-lasting growth.On January 23, 2007, Leopoldo Pirelli, Honorary Chairmen of thecompany passed away. The memory full of respect and affection isnot only mine and that of family and friends alike but of all thosewho have, as Pirellians, lived the entrepreneurial adventure of thecompany from the postwar period until today.

8




Directors’ report on operations

To the Shareholders,

The Pirelli & C. S.p.A. Group closed the year 2006 with a further growth in its operating resultscompared to 2005.

The consolidated income statement shows a significant increase in revenues (+6.5 percent over theprior year) near the threshold of Euros 5 billion and a double-digit increase in operating profit(+13.1 percent) which exceeds Euros 400 million, thanks to the good performance of the corebusinesses in the tyres and real estate sectors in addition to an improvement in the broadband andenvironment businesses in the start-up stages.

The loss for the year of Euros 1,048.8 million was significantly impacted by the impairmentadjustment made to the carrying amount of the investment held by Pirelli & C. S.p.A. in OlimpiaS.p.A.. This adjustment, on consolidation, is equal to Euros 2,110 million and corresponds to atransparent valuation of Olimpia’s assets (that is, the Telecom Italia S.p.A. shares held by Olimpia) atEuros 3 per share as compared to the previous valuation at approximately Euros 4 per share.

The reduction in the recoverable amount of the investment which occurred during the course of 2006can be ascribed to the stock market performance of Telecom Italia S.p.A. shares – lower than boththe European sector indexes and the expectations of Pirelli management – and the decline in thetarget prices by analysts.

Having established the effective existence of an impairment of the investment, in order to determinethe amount of the impairment loss, the recoverable amount of the Telecom Italia S.p.A. shares wasestablished by reference to the value in use, taking into account the observations formulated byConsob.

For purposes of estimating the value in use since there is neither a preference nor a consolidatedpractice relative to the two measurement techniques set forth in IAS 28.33, it was decided to useboth estimation criteria in order to ensure a consistent result under a plurality of calculationmethods and measurement techniques. This refers to:a) the so-called asset side criterion which considers the operating flows of the investee and the

consideration deriving from the final disposal of the investment; b) the so-called equity side criterion which considers the flows from expected dividends and from

the disposal of the investment.

In order to estimate the value in use, all the factors that market participants would consider weretaken into account and, in particular:a) flows from operating results and dividends, as well as the discount and capitalization rate used by

the analysts (aligned with the consensus) who follow Telecom Italia S.p.A. stock; b) multiples of comparable transactions for the estimate of the final amount under the asset side

criterion; c) premiums paid in transactions involving listed companies operating in the telecommunications

sector both in Europe and in the United States (the country where the concentration process ofthe sector first began) to arrive at the estimate of the consideration deriving from the disposal ofthe stock under the equity side criterion.

The two criteria for the estimate of the value in use gave a recoverable amount of between Euros 3and Euros 3.2. The company deemed it appropriate to adjust the carrying amount of the investmentto an equivalent amount of Euros 3 per Telecom Italia S.p.A. ordinary share.

9


A IntroductionThe Group2006 operating andfinancialMajor events in 2006Group consolidationPirelli LabsSignificant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocumentsPirelli TyrePirelli BroadbandSolutionsPirelli & C. Real EstatePirelli & C. AmbienteInformation systemsProforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plansCorporate GovernancePirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

In October 2006, Pirelli Tyre inaugurated a car tyre factory in Romania

After this adjustment, the consolidated equity of Pirelli & C. S.p.A.at December 31, 2006 is equal to Euros 4,686.6 million, comparedto a net financial debt position of Euros 1,979.6 million. The equityof the parent, Pirelli & C. S.p.A., after the impairment loss on theinvestment, is equal to Euros 2,882.3 million (inclusive of share capitalamounting to Euros 2,790 million).The adjustment of the investment in Olimpia S.p.A., therefore, has norepercussions on the equity and financial soundness of the companyand the group.

In the industrial businesses, Pirelli Tyre closed 2006 with anincrease in revenues of just under 9 percent and growing operatingresults despite the increase in raw material costs that penalized thetyre sector all over the world.

In the real estate business, Pirelli Real Estate recorded double-digit growth in operating profitincluding earnings from investments (+15 percent), reaching the top of the range indicated in the2006-2008 three-year plan (CAGR 10-15 percent) and a significant increase in assets undermanagement at market value, which amount to approximately Euros 14.5 billion.

As for the start-ups, Pirelli Broadband Solutions in 2006 reported an increase in net sales of over15 percent, closing the year with at breakeven at the operating level.

Pirelli Ambiente also reached an operating breakeven and confirmed the trend of sales growth.

Furthermore, in 2006, the Pirelli Group continued to expand its international presence in allsectors of activity. Pirelli Tyre opened a new truck-tyre facility in Brazil and production of car tyrescame on line at the new plant in Romania. Pirelli Real Estate began to expand its foreign businesswith important transactions in Poland and, more particularly, in Germany, where an agreement wassigned to acquire DGAG, one of the most important German real estate companies. Pirelli BroadbandSolutions commenced expansion of its international activities by marketing its products throughoutEurope. Pirelli Ambiente took its first steps by building the first plant for manufacturing anti-particulate filters in Romania for the original equipment market.

As for Olimpia S.p.A., during 2006, Pirelli raised its investment from 57.7 percent to 80 percentfollowing the purchase of the stakes of Hopa S.p.A., Banca Intesa S.p.A. and UniCreditoItaliano S.p.A.. It should be recalled that on November 7, 2006, the board of directors of Pirelli& C. S.p.A. decided to adjust the carrying amount of the investment held in Olimpia S.p.A.,as previously mentioned.

10


Assets managed by Pirelli RE in 2006total more than Euros 14 billion

A IntroductionThe Group2006 operating andfinancialMajor events in 2006Group consolidationPirelli LabsSignificant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocumentsPirelli TyrePirelli BroadbandSolutionsPirelli & C. Real EstatePirelli & C. AmbienteInformation systemsProforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plansCorporate GovernancePirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

11


The Group2006 operating and financial

Consolidated net sales of the group in 2006 amount to Euros 4,841.2 million. This is an increaseof 6.5 percent compared to Euros 4,545.7 million in 2005, with gains recorded in all businessactivities. Excluding the exchange effect, net sales grew by 5.1 percent.

Consolidated gross operating profit is Euros 614.1 million (12.7 percent of net sales) up 8.2percent compared to Euros 567.6 million (12.5 percent of net sales) in 2005. Excluding nonrecurringexpenses incurred for the project to list Pirelli Tyre S.p.A. (Euros 13.2 million), consolidated grossoperating profit is Euros 627.3 million (13 percent of net sales) with an increase of 10.5 percentcompared to 2005.

Consolidated operating profit amounts to Euros 401.4 million, an increase of 13.1 percentcompared to Euros 354.9 million in 2005 with growth across all business segments. The profit margin(ROS - Return on Sales) at the consolidated level is equal to 8.3 percent, a further increase over 7.8percent in 2005. Excluding nonrecurring expenses incurred for the project to list Pirelli Tyre S.p.A.(Euros 13.2 million), consolidated operating profit is Euros 414.6 million (+16.8 percent over 2005)with a ROS of 8.6 percent (7.8 percent in 2005).

Earnings (losses) from investments show a loss of Euros 1,149.3 million, compared to earnings ofEuros 267.1 million in 2005. The caption includes the impairment loss on the investment in OlimpiaS.p.A. (Euros 2,110 million) and is countered by the gain realized on the private placement of the 38.9percent stake in Pirelli Tyre S.p.A. (Euros 416.4 million) and the sale of the investment in CapitaliaS.p.A. (Euros 215.2 million). It also comprises the result of the companies accounted for using theequity method and dividends from other unconsolidated holdings.Olimpia S.p.A., in particular, contributed earnings of Euros 170.0 million compared to Euros 152.5million in 2005. It should be recalled that the financial statements of Olimpia S.p.A., included in theconsolidated financial statements of the group, have been drawn up in accordance with IFRS andcomprise the valuation of the investment in Telecom Italia S.p.A. by the equity method. The captionalso includes the results of the companies in the real estate sector accounted for by the equitymethod, which show earnings of Euros 110.7 million (Euros 102.3 million in 2005).

The consolidated net result in 2006, which was influenced by the aforementioned impairmentloss on the investment in Olimpia S.p.A. for an amount of Euros 2,110 million, is a loss of Euros1,048.8 million, compared to income of Euros 398.9 million in 2005. Excluding nonrecurring items(the impairment loss on the investment in Olimpia S.p.A., the gains on the sales of the 38.9 percentstake in Pirelli Tyre S.p.A. and the investment in Capitalia S.p.A. and the costs of the Pirelli TyreS.p.A. IPO project), and on a comparable consolidation basis (net of the loss from discontinuedoperations), the net result would be income of Euros 472.8 million, with an increase compared toEuros 349.1 million in 2005.

As regards discontinued operations (the Cables and Systems activities), which in 2005 recordedincome of Euros 49.8 million, a loss of Euros 30 million was reported in 2006 due to the adjustmentof accruals as a result of reaching an agreement on the price adjustment provided by the contractand the guarantees given.

The loss attributable to the equity holders of Pirelli & C. S.p.A. in 2006 is Euros 1,167.4 million(-Euros 0.217 per share) compared to income of Euros 327.4 million in 2005 (Euros 0.066 per share).Excluding nonrecurring items (impairment of Olimpia, gain on the sale of the stake in Pirelli Tyre,gain on the sale of the investment in Capitalia and IPO project costs) and considering a comparable

IntroductionThe Group

A 2006 operating andfinancialMajor events in 2006Group consolidationPirelli LabsSignificant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocumentsPirelli TyrePirelli BroadbandSolutionsPirelli & C. Real EstatePirelli & C. AmbienteInformation systemsProforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plansCorporate GovernancePirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

consolidation basis (net of the loss from discontinued operations),the income attributable to the equity holders of Pirelli & C. S.p.A. isEuros 354.2 million, an increase compared to Euros 277.6 million in2005.

The loss of the parent, Pirelli & C. S.p.A., is Euros 1,642.3million in 2006 (income of Euros 139.8 million in 2005). In view ofthis result, the Company will not pay dividends for the year 2006.The loss will be absorbed from existing reserves.

Total consolidated equity at December 31, 2006 is Euros 4,686.6million compared to Euros 5,613.8 million at December 31, 2005. Thechange from the end of 2005 is mainly due to the impairment loss onthe investment in Olimpia S.p.A..

Equity attributable to the equity holders of Pirelli & C. S.p.A.at December 31, 2006 is Euros 3,879.6 million (Euros 0.723 pershare) compared to Euros 5,204.9 million at December 31, 2005(Euros 0.979 per share).

The equity of the parent, Pirelli & C. S.p.A., is equal to Euros2,882.3 million which includes Euros 2,790.0 million of share capital.

The net financial position of the group at December 31, 2006 is a net financial debt position ofEuros 1,979.6 million, reflecting the forecast announced to the market. The change from the netfinancial debt position of Euros 1,430.8 million at September 30, 2006 is primarily due to thedifference between the outlay for the purchase of the 9.54 percent stake in Olimpia S.p.A. fromBanca Intesa S.p.A and UniCredito Italiano S.p.A. (Euros 1,040 million), the proceeds on the sale ofthe 1.92 percent stake in Capitalia S.p.A. (Euros 333.0 million) and the cash generated by operatingactivities during the period. The net financial debt position was Euros 1,177.4 million at December 31,2005. The change on an annual basis is primarily due to the factors mentioned previously and thedisbursements made during the first nine months of the year (purchase of Olimpia S.p.A. fromHopa S.p.A. for Euros 497.7 million, purchase of Telecom Italia S.p.A. shares for Euros 201.0 millionand dividends paid for Euros 162.7 million) against the net proceeds collected on the sale of the 38.9percent stake in Pirelli Tyre S.p.A. (Euros 715.8 million).

Major events in 2006

The major events which occurred in 2006 are described below:

Corporate

• On February 6, 2006, Olimpia S.p.A. and the shareholders Pirelli & C. S.p.A., Edizione FinanceInternational S.A., Edizione Holding S.p.A., Banca Intesa S.p.A. and UniCredito Italiano S.p.A. sentHopa S.p.A. the statement withdrawing from the agreement signed among the parties in 2003.Therefore, at the expiration date (May 8, 2006), this agreement was not renewed.Subsequently, on July 4, 2006, Pirelli & C. S.p.A., Edizione Finance International S.A. and EdizioneHolding S.p.A. together with Hopa S.p.A. communicated that they had reached full agreement overall the aspects relating to the cash settlement of the investments held in Olimpia S.p.A. and inHolinvest S.p.A. following the dissolution of the shareholders’ agreements that were already inexistence among the above companies.

12


Consolidated net sales by the Pirelli Groupgrew by 6.5% over 2005

IntroductionThe Group

A 2006 operating andfinancial

A Major events in 2006Group consolidationPirelli LabsSignificant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocumentsPirelli TyrePirelli BroadbandSolutionsPirelli & C. Real EstatePirelli & C. AmbienteInformation systemsProforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plansCorporate GovernancePirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

This agreement provided for:- the purchase on the part of Pirelli & C. S.p.A., Edizione Finance International S.A. and Edizione

Holding S.p.A. of all the shares held by Hopa S.p.A. in Olimpia S.p.A. (equal to 16 percent ofcapital) for a cash settlement of Euros 622 million (of which Euros 208 million relates to thepremium to which Hopa had the right on the basis of previous agreements);

- the purchase on the part of Hopa S.p.A. of all the shares held by Olimpia S.p.A. in HolinvestS.p.A. (equal to 19.999 percent of capital) for a cash settlement of Euros 86 million.

Holinvest S.p.A., at that date, was the owner of 492,697,862 Telecom Italia S.p.A. shares, equal toabout 3.68 percent of ordinary share capital.On the basis of the terms of the agreement, 320,253,610 Telecom Italia S.p.A. shares held byHolinvest S.p.A. (equal to 65 percent of the total shares in its possession) are covered by apre-emptive two-year agreement in favor of Olimpia S.p.A. which also establishes thatHolinvest S.p.A. may not effect new purchases of Telecom Italia S.p.A. shares without the prioragreement of Olimpia S.p.A. during the same period. The purchases of the investments and thesigning of the pre-emptive agreement were finalized on July 12, 2006.Specifically, Pirelli & C. S.p.A. purchased 12.8 percent of Olimpia S.p.A. for an outlay of Euros 331million. At the same time, it paid its share of the premium due to Hopa S.p.A. of Euros 166 million,which had already been set aside in the 2005 financial statements.

• On February 14, 2006, the Pirelli & C. S.p.A. board of directors voted to undertake a courseof action that would lead to the best way of appreciating the value of the tyres division (“PirelliTyres”), including its listing on the Electronic Trading Market of Borsa Italiana, with theunderstanding that Pirelli & C. S.p.A. would still hold the majority of the shares of Pirelli Tyres.In addition to the project to appreciate the value of Pirelli Tyre, the board of directors alsoapproved a plan for the further concentration of resources in the strategic businesses of the groupthrough the disposal of financial investments for an equivalent amount of approximately Euros 400million at current values, equal to about a half of that portfolio.

• On April 10, 2006, Pirelli Pneumatici S.p.A. (which later took the name of Pirelli Tyre S.p.A.),the company which heads all the tyre design, development, manufacturing and marketing activitiesof the Pirelli & C. S.p.A. Group, filed a request to list its ordinary shares with Borsa Italiana, withthe shares to be put up for a public offering of sale by the 100-percent parent, Pirelli Tyre HoldingN.V., a company which, in turn, is a wholly-owned subsidiary of Pirelli & C. S.p.A..Subsequently, on June 30, 2006, the board of directors of Pirelli & C. S.p.A., – after the sameresolution was passed by Pirelli Tyre Holding N.V. – decided not to go through with the IPO at theend of the offering period of the Pirelli Tyre S.p.A. shares. Pirelli & C. S.p.A. deemed that thefinancial market conditions and, in particular, the stock market performance of the principal worldtyre operators, would not make it possible to accurately and adequately value Pirelli Tyre S.p.A. sothat it would reflect the intrinsic value of the company which is recognized as one of the mostimportant tyre companies in the world in terms of profitability, positioning and capacity forinnovation.

• During the first half of 2006, Pirelli Finance (Luxembourg) S.A., a wholly-owned subsidiary ofPirelli & C. S.p.A., exercised two call options on Telecom Italia S.p.A. shares for a total of75,000,000 ordinary shares (equal to 0.56 percent of ordinary share capital) at the average price ofEuros 2.35 per share for a total investment of Euros 176 million.Furthermore, during the same period, 10,400,000 Telecom Italia S.p.A. ordinary shares werepurchased on the market (equal to 0.08 percent of ordinary share capital) at an average price pershare of Euros 2.40 for a total investment of Euros 25 million.

13


IntroductionThe Group2006 operating andfinancial


A forward share transaction signed on April 20, 2006 was put into place with Banca Caboto on theshares held by Pirelli Finance (Luxembourg) S.A. (134,957,885). The shares were sold at the spotprice per share of Euros 2.42 for a total of Euros 326.3 million and were subsequently repurchasedon August 14, 2006 at a per share price of Euros 2.31 for a total of Euros 312 million.At December 31, 2006 Pirelli & C. S.p.A. holds, directly and indirectly, through Pirelli Finance(Luxembourg) S.A., 182,113,185 Telecom Italia S.p.A. ordinary shares (equal to 1.36 percent ofordinary share capital).

• On March 27 and 28, 2006, Banca Intesa S.p.A. and UniCredito Italiano S.p.A. communicated theirintention to withdraw from the shareholders’ agreement, regarding the investment in Olimpia S.p.A.concluded in September 2001 with Pirelli & C. S.p.A., and consequently to exercise the right to selltheir investments (equal to about 4.77 percent for each bank) to Pirelli & C. S.p.A..The execution of the purchase of the investment took place at the expiration of the pact onOctober 4, 2006. Pirelli & C. S.p.A. purchased the investments in Olimpia S.p.A. held by BancaIntesa S.p.A. (4.77 percent) and UniCredito Italiano S.p.A. (4.77 percent) against payment ofapproximately Euros 585 million to each bank. The transaction was funded by cash and by theutilization of available credit lines. The impact of the purchase on the net debt of Pirelli & C. S.p.A.was about Euros 1,040 million, since part of the payment (approximately Euros 130 million) hadalready been considered, in accordance with IFRS, in the debt of the company as at December 31,2005.

• On April 27, 2006, Pirelli Labs S.p.A., the Pirelli Group’s center oftechnological excellence, and ENEA, Ente per le NuoveTecnologie, l’Energia e l’Ambiente, launched three hi-tech researchprojects in the field of renewable energy sources and sustainabledevelopment within the sphere of a special five-year frameworkagreement. The first research projects launched involveconcentrated photovoltaic cell technology, a new generation ofsensors for monitoring the environment and, finally, groundworkstudies in the field of cold fusion. The agreement between ENEAand Pirelli Labs also calls for the definition of other researchprojects in sectors of mutual interest. The beginning of thispartnership is further proof of Pirelli’s commitment to the field oftechnologies for sustainable development.

• On June 16, 2006, Pirelli & C. S.p.A. sold a 15.26 percent stake inF.C. Internazionale Milano S.p.A. to the current majoritystockholder of that company for Euros 13.5 million. Thistransaction falls under the program approved by the meeting held by board of directorsof Pirelli & C. S.p.A. on February 14, 2006 to further concentrate on its core business partly bydisposing of non-strategic financial investments.Pirelli & C. S.p.A., however, remains a shareholder of F.C. Internazionale Milano S.p.A. with a 4.2percent stake. It is the company’s intention to continue its current sponsorship relationship with F.C.Internazionale Milano S.p.A. and evaluate any new future possibilities of collaboration, especially inlight of the considerable benefits this partnership has brought to the Pirelli brand over the years.

• On July 27, 2006, the board of directors of Pirelli & C. S.p.A. examined a transaction with someleading Italian and international financial institutions (Banca Intesa, Banca Leonardo Group,Capitalia, One Equity Partners – JP Morgan, Lehman Brothers and Mediobanca) for the sale of aminority interest in the capital of Pirelli Tyre S.p.A., for the purpose of a later IPO. Subsequently,on July 29, 2006, the relevant agreements were reached for the sale of 38.9 percent of the capital ofPirelli Tyre S.p.A. for consideration equal to Euros 740 million, with an equity value for the entire

14


One of Pirelli Labs most recentaccomplishments, the development ofnew-generation environmental sensors



company of about Euros 1.9 billion, with realization of a gain onthe transaction of approximately Euros 416 million. The purchaseof the minority interest in Pirelli Tyre S.p.A., finalized on August 2,2006, was carried out by Speed S.p.A., an Italian company in whichabout a 19 percent stake each is held by Banca Intesa, Capitalia,One Equity Partners – JP Morgan Group, Lehman Brothers andMediobanca and about a 4 percent stake by the Banca LeonardoGroup. The agreements provide that the purchasing company maystart and conduct, within a period of four years and six monthsfrom the closing date, an Initial Public Offering of the sharesacquired.Pirelli has the right to repurchase the shares that were sold in theevent in which, after four years and six months, the shares havenot been placed in an IPO.The relationships between the seller and the buyer are regulatedby shareholder agreements which provide, among other things, that the acquiring company maydesignate five out of the thirteen directors on the board of directors of Pirelli Tyre S.p.A. andappoint a member of the board of statutory auditors.After a lock-up period of six months, and after receiving Pirelli’s approval, the acquiring companyor its shareholders will have the right to sell up to 49 percent of the shares originally purchased toqualified parties (leading financial institutions or mutual funds).A commission of 3 percent of the equivalent amount of the transaction was paid to the financialinstitutions and an additional 1 percent will be paid on an annual basis until the IPO.

• On September 28, 2006, in implementing the plan for the disposal of financial investmentscommunicated to the market on February 14, 2006, Pirelli & C. S.p.A. announced that it hadinformed the participants of the Capitalia Shareholders’ Agreement of its intention to sell itsinvestment in the company (about 1.92 percent of share capital), entirely contributed to theAgreement.The offer was finalized on October 26, 2006 with the sale of 49,689,476 shares for a total ofapproximately Euros 333 million, realizing a gain, on consolidation, of about Euros 214 million.The shares offered with the right of first refusal to the parties in the Capitalia Shareholders’Agreement for consideration of approximately Euros 6.6993 euro per share, were purchased by:ABN Amro Group (24,606,761 shares), Fondazione Mondadori (6,612,508 shares), Fondiaria SAIGroup (10,041,915 shares), Cinecittà Centro Commerciale S.p.A. (4,535,779 shares), Fininvest S.p.A.(3,204,468 shares) and Fineldo S.p.A. (688,045 shares).

• On October 18, 2006, Olimpia, Pirelli, Edizione Holding, Edizione Finance International,Mediobanca and Generali signed a shareholders’ agreement in which Olimpia, Mediobanca andGenerali contributed a total of 23.2 percent of Telecom Italia S.p.A. ordinary capital. With thesigning of this agreement, the intention of the Parties is to ensure the continuity and stability of theshareholder base and the governance of the Telecom Italia group with the aim of sustaining itsindustrial development in a context of economic and financial equilibrium for the creation of valuefor all the shareholders.The three-year agreement is managed by a body, the Board, in which all the Parties are membersand the Chairman is designated by Olimpia S.p.A. The agreement establishes, in particular:1. the obligation of the Parties to consult with each other before each Telecom Italia S.p.A.

shareholders’ meeting on how to exercise their voting rights, with the understanding that eachParty may freely exercise the right to vote in Telecom Italia shareholders’ meeting where theBoard of the pact does not unanimously agree;

2. the possibility of admitting to the agreement new Parties having at least a 0.5 percent stake;

15


On August 2, 2006, a 38.9% stake in PirelliTyre S.p.A. was acquired by Speed S.p.A.



3. lock-up on the Telecom Italia S.p.A. shares in the agreement, except for limited operationalthresholds;

4. the possibility that Olimpia sells its entire holding, subject to the right of first refusal ofMediobanca and Generali; such right of first refusal shall not apply in the case of an offer to buythe shares held by Olimpia, Mediobanca and Generali. The same mechanism is applicable in theevent of a sale by Pirelli, alone or together with Edizione, to third parties, of an interest inOlimpia S.p.A. exceeding 50 percent; sales by Pirelli, alone or together with Edizione, up to thatceiling are not restricted;

5. the possibility that Mediobanca and Generali purchase additional shares up to a maximum of 25percent of the Telecom Italia shares contributed in the pact by each of them;

6. the possibility that Olimpia increases its share capital by way of a contribution in kind ofTelecom Italia S.p.A. shares by new shareholders.

• On December 5, 2006, Pirelli Labs, the center for advancedresearch of the Pirelli Group, and the Istituto sull’InquinamentoAtmosferico (Institute of Atmospheric Pollution) of the CNR(National Research Center) (CNR-IIA), presented a project formonitoring the quality of air and the levels of electromagnetic andacoustic pollution in real time which will take place in the city ofParma until May 2007. Such activity will be conducted by means ofinnovative experimental technologies and will cover the cityenvirons and the decentralized area near the A1 toll road junction.

• On December 21, 2006, Pirelli & C. S.p.A. announced that theperiod of the revolving committed credit line of Euros 1 billion,arranged in 2003 with a pool of international banks andrenegotiated in 2005, was further extended from 2010 to 2011. The mandated lead arrangers ofthe loan are Barclays Capital, BNP Paribas, HSBC Bank plc, J.P. Morgan plc and The Royal Bankof Scotland plc. The extension of the period of the credit line, at the same costs, allows Pirelli &C. S.p.A. to improve its financial structure.

Tyres Sector

• On March 22, 2006, Pirelli Pneus S.A. opened a new plant for manufacturing radial tyres for trucksand buses at Gravataì, in the Brazilian state of Rio Grande do Sul. The production unit is located inan area which already constitutes the group’s main center for the development and production ofconventional Motorcycle tyres. With a surface area of 573,000 m2, the new plant adds about 500

16


Pirelli Labs teams up with CNR-IIAon innovative atmospheric monitoringprojects

In March 2006, a new radial truck tyre factory was inaugurated at Gravataì (Brazil)



employees (direct and allied) to the current approximate 1,500 work force, and, when fullyoperational, will have a production capacity of 12,000 tons a year in addition to the current64,000-ton production capacity.80 percent of the Gravataì production is destined for the domestic market and 20 percent forexport, mainly to countries in Latin America. The new plant calls for an overall investment ofapproximately Brazilian reais 116 million (more than US$ 50 million) and, when fully operational,will contribute 8 percent to the sales of Pirelli Tyre in Brazil.The opening of the new Gravataì plant has given another boost to Pirelli’s presence in the radialTruck tyre segment after the launch, in the second half of 2005, of production activities in China.These factories complete Pirelli Tyre’s investment program in the Industrial market, which can nowcount on new and more competitive production capacity to meet the growth in demand over thethree-years 2006-2008.The investment in Gravataì is part of Pirelli Tyre’s growth strategy on a global scale, whichinvolves expanding into emerging markets in the Industrial market and focusing on the Carand Motorcycle Premium segments. The new plant joins other Pirelli plants in the radialTruck segment which are already operating in Italy, Turkey, Egypt, China and the Brazilianplant of Santo André.

• On May 8, 2006, Pirelli and Schrader Electronics signed an agreement with the aim of developingand marketing an innovative system, located, for the first time, directly inside the tyre and capableof detecting all kinds of identifying data in addition to temperature and pressure. The heart of thesystem consists of a miniature sensor which can function without batteries thanks to its capacityto generate its own energy.Thanks to the new sensor, the tyre is able to interact with the vehicle, optimizing the on-boardelectronic systems, whose parameters adapt according to the information received from the device,leading to improved safety and performance.The system, which was specially developed for original equipment, is particularly suitable for RunFlat tyres, since it allows for optimum management of the parameters when traveling with a flattyre caused by a puncture.

• On May 11, 2006, Francesco Gori, managing director of Pirelli Tyre, was elected president of theEuropean Tyre and Rubber Manufacturers Association – ETRMA. The new non-profit organizationreplaces the previous representative body of rubber industries founded in 1959 and has the aim ofrepresenting the tyre and rubber product industry within European Union institutions and otherinternational organizations.

• On October 26, 2006, Pirelli Tyre officially started up tyreproduction in Romania in the new factory at Slatina. With aninvestment of about Euros 170 million, the new production facilitywill manufacture top-of-the-range tyres for cars and SUVs and islocated near the steelcord factory inaugurated last year.The industrial complex, steelcord included, extends over an areaof 500 thousand m2 and, at the end of the year will employeeabout 770 employees, 450 of whom will work in tyres. The year2006 will close with a production of 300 thousand tyres which willrise to 2 million in 2007.When fully operational, the new factory will be able tomanufacture 4.5 million high-performance tyres a year, with abouta 1,000-person work force. The group is thus building up itspresence in Eastern Europe with an annual growth target set atmore than 10 percent per year. Pirelli intends to take advantage ofthe Slatina area by adding a platform of logistics, computer andcommercial services to the industrial activities to support its

17


When fully operational, the Romanianproduction facility at Slatina will be able toproduce 4.5 million tyres a year



expansion in those countries. Moreover, Pirelli also has plans for aseries of initiatives to promote the training and the wellbeing of itsemployees and their families and the local area in general.

• On November 24, 2006, the city of Settimo Torinese and PirelliTyre signed a protocol agreement for the industrial relaunching ofthe area where the Pirelli Group company has two separateproduction facilities making tyres for cars and industrial vehicles.Under the agreement, the production activities currently located inthe car-tyre facility will be transferred to the facility which makestyres for industrial vehicles.The unification of production activities will make it possible toexpand and modernize the plants. By creating a single industrialcomplex of a size and with technology which are better suited toPirelli Tyre’s requirements, the company will be able to become even more firmly established inthis important area of Piedmont. The aim of unifying the two production facilities is to develop amodern industrial hub which will use cutting-edge innovative technologies.

Pirelli Broadband Solutions

• On September 27, 2006, Pirelli Broadband Solutions reached an agreement with ArasorInternational Limited, a Chinese company specializing in integrated solutions in the field of opticsand wireless communications, to develop new optical components for telecommunicationsnetworks. Under the agreement, a new line of ITLA (Integrable Tunable Laser Assembly) opto-electronic components will be jointly developed and subsequently marketed. The components,which will be based on Pirelli’s tunable laser, an innovative optical device using nanotechnology,through software, can rapidly change the wavelength of signals, achieving the same amount ofwork as more than 100 fixed conventional lasers, while guaranteeing very high spectral purity andfrequency stability. These components will be used with the aim of augmenting flexibility andreducing the running costs of metropolitan telecommunications networks.The devices will be produced in the Arasor facility at Guangzhou, whereas the tunable lasers onwhich the system is based will be produced by Pirelli in Italy. To begin with, the new componentswill be destined for the Chinese market, in particular to the Huawei Technologies group, one of theworld’s key players in the field of optical solutions for telecommunications operators.

• On October 11, 2006, Pirelli Broadband Solutions and Arcor (Vodafone Group), the second largestland-line operator on the German market, reached an agreement for the supply of Pirelli’s newdual-mode telephones. These phones will be used by the German operator as part of the launch ofa new offer for telephone services via Internet (Voice Over IP).The Pirelli dual-mode telephone is an innovative phone whichsupports the integration of land-line and mobile telephoneservices, combining the technology of cell phones with theadvantages of telephony via Internet.Based on SIP protocol (Session Initiation Protocol), the newPirelli telephone can act alternatively as a land-line telephonein Wi-Fi mode and as a cell phone. With the dual-mode telephone,the user can make calls from a cell phone using a normal SIMcard or call via Internet with a DSL connection. The solutionmakes it possible to use mobile telephone services such as SMS,MMS, e-mail and Internet also through a broadband connectionon a land-line network, with important benefits in economic termsand from the standpoint of bandwidth capacity.

18


An agreement with the city of SettimoTorinese will lead to the relaunching of thetwo historic Pirelli plant facilities for carand truck tyres

Pirelli Broadband Solutions’ dual modetelephone is an apparatus integrating fixedand mobile telephones using internetstandards



Pirelli Ambiente

• On August 25, 2006, Pirelli & C. Ambiente Eco Technology S.p.A.,a company in the group working in the sector of sustainabledevelopment technologies, received a Special Award for itsinnovative solutions promoted in the area of sustainabletransportation, specifically for the emulsion diesel fuel Gecam™, atthe 2006 edition of the World Renewable Energy Congress (WREC).This international congress was held in Florence and sponsored bythe Florence Università degli Studi and the Architettura Bioecologiae Innovazione Tecnologica per l’Ambiente Center (ABITA).

• On November 29, 2006, Pirelli Ambiente, a company in the Pirelli& C. Group also active in the sector of sustainable developmenttechnologies, signed in Romania, in the presence of localauthorities, the lease contract for the land on which a productionfacility will be built for the manufacturing of anti-particulate filtersfor vehicles, destined for the original equipment market.The plant, spread over 10 hectares in the Gorj County IndustrialPark in the southwest of Romania, will start manufacturing in thesecond half of 2008 on two production lines. The new factory,on which work will commence in January 2007 and operationswill start in the second half of 2008, will produce more than1,300 tons of silicon carbide filters per year.

Real estate activities

• On January 12, 2006, after winning the bid concluded on October 14, 2005 for the purchase of aresidential property portfolio in Berlin at the price of Euros 72.5 million, ownership was formallytransferred to Tizian Wohnen 1 and Tizian Wohnen 2, in which investments are held by thesubsidiary P&K Real Estate. The properties purchased were part of the Corpus Immobiliengruppeproperty portfolio.

• On February 16, 2006, Pirelli Real Estate and the Corporate Credit group of Morgan Stanleyfinalized the acquisition of the former BNL non-performing loan portfolio that was awarded at theend of last year for approximately Euros 345 million. At the same time, a portion of the portfoliowas sold to Deutsche Bank for approximately Euros 102 million. The transaction was concludedthrough the purchase of 35 percent of the securities from the securitization of the above portfolioby Esphela – Serviços de Consultadoria (in which Pirelli Real Estate has a 49 percent stake).

• On February 20, 2006, Pirelli Real Estate and Merrill Lynch signed a binding agreement to set up ajoint venture (with a 35 percent stake by Pirelli Real Estate and a 65 percent stake by MerrillLynch) for the investment of Euros 1.5 billion in the hotel tourism sector in Italy over the next fiveyears.On June 22, 2006, Pirelli & C. Real Estate Opportunities SGR S.p.A. received approval to start theactivities of Fondo Hospitality&Leisure, specialized in the tourism-hotel sector. The shares of thisfund have been subscribed to by the Pirelli Real Estate-Merrill Lynch joint venture. The firstinvestment was concluded with four tourist resorts seeded by Valtur located in Pila, Nicotera,Marileva and Ostuni worth approximately Euros 103 million. Over the next two years, thestructures are scheduled to be appreciated through an investment of approximately Euros 12million.

19


Special award received in 2006 from theWorld Renewable Energy Congress for theemulsion diesel fuel “Gecam™”, producedby Pirelli Ambiente



In 2006 the Polish Investment RE Holdingactivities began in Poland. A joint venturebetween Pirelli RE and Cypress Grove Int.

20

• On March 29, 2006, the second investment of the Raissa FondoUffici was finalized when 201 properties worth approximatelyEuros 158.1 million were contributed by Olivetti Multiservices(Telecom Italia Group). The contribution of the properties is inaddition to the properties conferred on December 28, 2005 worthabout Euros 486 million.

• On May 31, 2006, Resident Berlin 1 P&K GmbH undertook acommitment for the purchase of 16 buildings located in Berlinmainly for residential use at a price of Euros 61.1 million.

• On June 28, 2006, Pirelli Real Estate, together with ConwertImmobilien and Eco Business-Immobilien, won the bid for thepurchase from Allianz of a property portfolio in Austria worthapproximately Euros 207 million (net of closing costs and abuilding on which there is a right of first refusal). This propertyportfolio is principally located in the cities of Vienna, Innsbruckand Salzburg and is composed (again net of the building onwhich there is a right of first refusal) of 30 mainly residentialbuildings and 47 buildings for office and commercial use. PirelliReal Estate later monetized the investment in the second half ofthe year by selling its shares.

• On September 1, 2006, the Polish Investment Real Estate HoldingB.V. joint venture was set up between Pirelli Real Estate (40percent) and Cypress Grove International (60 percent) forinvesting in the residential sector in Poland. The aim of the jointventure is to develop residential projects over the next threeyears for approximately Euros 1.5 billion. The first transaction ofthe joint venture was the purchase from Pirelli Pekao Real EstateSp.zo.o, on September 26, 2006, of Nowe Ogrody Sp.zo.o, acompany owning land and building complexes located in Warsaw.Thus the first stage of the investment project commenced whichconsists of realizing approximately 3,300 apartments worthapproximately Euros 420 million once the work is completed.

• On October 9, 2006, Pirelli Real Estate signed a bindingagreement for the purchase of about 97 percent of DeutscheGrundvermögen (DGAG), one of the most important real estatecompanies in Germany with offices in Hamburg and Kiel. OnDecember 19, 2006, the pertinent antitrust authority approved thepurchase which was finalized on January 10, 2007. Greater detailsare provided under subsequent events.

• On October 13, 2006, the placement of Spazio Investment N.V.was successfully concluded on the Alternative Investment Marketof the London Stock Exchange (AIM). Spazio Investment N.V. isregistered under Dutch law and at the placement date was65 percent-owned by Cypress Grove International and 35percent-owned by Pirelli Real Estate. The total offer of Euros 300million, composed of a capital increase (85 percent) forapproximately Euros 256 million and the sale of existing sharesby Cypress Grove International (15 percent) for approximately


The Hamburg and Kiel offices of theGerman real estate company DGAG,purchased by Pirelli RE in the early monthsof 2007



Euros 44 million, was subscribed to with a 10 percent NAV discount. Demand was considerablyhigher than the offer, 95 percent of which was subscribed to by leading international institutionalinvestors, mainly American and British. The placement price was fixed at Euros 12.5 per share. AtDecember 31, 2006 (the placement was closed on December 29, 2006), the shares of the companywere listed at Euros 14.95 per share (+20 percent). After the offering was closed, SpazioInvestment NV was 12 percent-owned by Pirelli Real Estate and approximately 88 percent-ownedby leading international investors, ten of which had stakes of more than 3 percent (the ceiling forpurposes of disclosure obligations for AIM). Among the major investors are Bank Julius Baer &Co., TIAA-CREF, Fidelity International, Lansdowne Partners, KDA Capital, New Star, Viking andTheorema, in addition to Cypress Grove.

• On November 2, 2006, after approval was received from the antitrust authority and the trustees ofthe securitizations, a joint venture was formed between Pirelli Real Estate (33 percent) and Calyon(67 percent). The newly established joint venture became operational in December 2006,purchasing 100 percent of five non-performing mortgage portfolios (with a residual gross bookamount at December 2005 of Euros 2.6 billion) held since 2004 by the Pirelli Real Estate andMSREF joint adventure. In December, the loan portfolio purchased from Banco Popolare di Veronae Novara on June 7, 2006 was also added to the non-performing loans of the joint venture.

• On December 29, 2006, Pirelli Real Estate and General Electric, through GE Real Estate and GECommercial Finance Services Italia won the bid for the purchase of the non-performing loans ofBanca Antonveneta and the subsidiary Interbanca (ABN AMRO Group) for a price ofapproximately Euros 299 million. The gross book amount of the portfolio is approximately Euros 1billion. The purchase transaction, which was concluded by the company Vesta Finance in whichPirelli Real Estate has a 35 percent investment, refers to a portfolio of loans receivable guaranteedby properties for residential, hotel and industrial use.

21




Group consolidationIn this report on operations, in addition to the financial performance measures established by IFRS,certain non-IFRS measures originated from the latter are presented although they are not requiredby IFRS (“Non-GAAP Measures”).These performance measures are presented for purposes of a better understanding of the trendof operations of the group and should not be construed as a substitute for the information requiredby IFRS.Specifically, the “Non-GAAP Measures” used are described as follows:- Gross operating profit: this financial measure is used by the group as the financial target in

internal business plans and in external presentations (to analysts and investors). It represents auseful unit of measurement for the evaluation of the operating performance of the group as awhole and for each single segment, in addition to the Operating Profit. The Gross Operating Profitis an intermediate performance measure represented by the Operating Profit from whichdepreciation and amortization are subtracted.

- Earnings (losses) from investments: earnings (losses) from investments consist of all theeffects recorded in the income statement referring to investments that are not consolidated line-by-line. These include dividends, the share of the earnings (losses) of companies accounted for usingthe equity method, impairment losses of available-for-sale financial assets and gains (losses) on thedisposal of available-for-sale financial assets.Movements in the fair value of assets available-for-sale that are recognized directly in equity areexcluded.

- Net financial (liquidity)/debt position: this performance measure is represented by the grossfinancial debt less cash and cash equivalents as well as other interest-earning financial receivables.The notes present a table that shows the balance sheet amounts used to calculate the net financial(liquidity)/debt position.

The highlights of the consolidated financial statements for the year ending December 31, 2006 can besummarized as follows:

(in millions of euros)12/31/2006 12/31/2005

Net sales 4,841.2 4,545.7Gross operating profit 614.1 567.6% of net sales 12.7% 12.5%Operating profit 401.4 354.9% of net sales 8.3% 7.8%Earnings (losses) from investments (1,149.3) 267.1Operating profit (loss) incl. earnings (losses) from investments (747.9) 622.0Financial income (expenses) (143.1) (144.4)Income taxes (127.8) (128.5)Income (loss) from continuing operations (1,018.8) 349.1% of net sales n.s. 7.7%Income (loss) from discontinued operations (30.0) 49.8Total income (loss) (1,048.8) 398.9Income (loss) attributable to the equity holders of Pirelli & C. S.p.A. (1,167.4) 327.4 Earnings per share (in euros) (0.217) 0.066 Total equity 4,686.6 5,613.8 Equity attributable to the equity holders of Pirelli & C. S.p.A. 3,879.6 5,204.9 Equity per share (in euros) 0.723 0.979 Net financial (liquidity)/debt position 1,979.6 1,177.4

Capital expenditures 255 234R&D expenditures 171 174Employees (number at year-end) 28,617 26,827 Factories 24 24 Pirelli & C. shares outstanding • ordinary shares (number in millions) 5,233.1 5,180.7 • savings shares (number in millions) 134.8 134.8 • Total shares outstanding 5,367.9 5,315.5

22


IntroductionThe Group2006 operating andfinancialMajor events in 2006

A Group consolidationPirelli LabsSignificant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocumentsPirelli TyrePirelli BroadbandSolutionsPirelli & C. Real EstatePirelli & C. AmbienteInformation systemsProforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plansCorporate GovernancePirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

For a more meaningful understanding of the performance of the group in its various segments of business,the following economic data and the net financial position are provided divided by business segment.

(in millions of euros) 2006Tyre Broadband Environment Real Estate Other Total

Net sales 3,949.5 129.4 69.0 702.0 (8.7) 4,841.2Gross operating profit (loss) 533.7 1.1 0.5 113.1 (34.3) 614.1Operating profit (loss) 342.3 (0.3) (0.2) 103.7 (44.1) 401.4Earnings (losses) from investments (2.4) (1.0) - 110.7 (1,256.6) (1) (1,149.3)Operating profit (loss) incl. earnings (losses) from inv. 339.9 (1.3) (0.2) 214.4 (1,300.7) (747.9)Financial income (expenses) (54.1) (1.6) (0.1) (3.1) (84.2) (143.1)Income taxes (86.5) (0.4) (0.5) (49.3) 8.9 (127.8)Income (loss) from continuing operations 199.3 (3.3) (0.8) 162.0 (1,376.0) (1,018.8)

Net financial (liquidity)/debt position 601.5 13.1 - 96.4 1,268.6 1,979.6

(in millions of euros) 2005Tyre Broadband Environment Real Estate Other Total

Net sales 3,632.9 112.2 61.5 700.2 38.9 4,545.7Gross operating profit (loss) 518.1 (6.3) (2.0) 92.8 (35.0) 567.6Operating profit (loss) 328.8 (7.0) (3.6) 83.9 (47.2) 354.9Earnings (losses) from investments (1.3) - - 102.3 166.1 (1) 267.1Operating profit (loss) incl. earnings (losses) from inv. 327.5 (7.0) (3.6) 186.2 118.9 622.0Financial income (expenses) (32.1) (0.7) - 1.2 (112.8) (144.4)Income taxes (97.0) (0.4) 0.2 (40.5) 9.2 (128.5)Income (loss) from continuing operations 198.4 (8.1) (3.4) 146.9 15.3 349.1

Net financial (liquidity)/debt position 237.4 7.2 0.8 30.5 901.5 1,177.4

(1) This includes the valuation of Olimpia S.p.A. by the equity method showing earnings of Euros 170 million (Euros 153 million in 2005), the writedown of OlimpiaS.p.A. for Euros 2,110 million, the gain on the private placement of Pirelli Tyres for Euros 416 million and the gain on the sale of the investment in Capitalia S.p.A.for Euros 215 million.

Net sales

Net sales amount to Euros 4,841.2 million and record an increase of 6.5 percent compared to theprior year (Euros 4,545.7 million).Excluding the foreign exchange effect (+1.4 percent), the effective change is equal to +5.1 percent.The distribution of net sales by geographical area is as follows:

2006 2005Tyres Sector 81.5% 79.9%Pirelli Broadband Solutions 2.7% 2.5%Environment Sector 1.4% 1.4%Pirelli Real Estate 14.4% 15.4%Other - 0.8%

A percentage breakdown of net sales on a comparable basis by business segment is as follows:

Tyres Sector + 7.0% Pirelli Broadband Solutions + 15.3% Environment Sector + 12.2% Pirelli Real Estate + 0.3% Total group + 5.1%Foreign exchange effect + 1.4%Total change + 6.5%

Operating profit

Operating profit in 2006 amounts to Euros 401.4 million, representing 8.3 percent of net salescompared to Euros 354.9 million in the prior year (7.8 percent of net sales). Excluding nonrecurringexpenses incurred for the project to list Pirelli Tyre S.p.A. (Euros 13.2 million), the consolidated

23




operating profit from ordinary operations is Euros 414.6 million (+ 16.8 percent) with a ROS of 8.6percent compared to 2005.The change in operating profit can mainly be attributed to (in millions of euros):

Operating profit 2005 354.9Tyres Sector 13.5Pirelli Broadband Solutions 6.7Environment Sector 3.4Pirelli Real Estate 19.8Other 3.1

46.5Operating profit 2006 401.4

Earnings (losses) from investments

Earnings (losses) from investments in 2006 amounts to losses of Euros 1,149.3 million compared toearnings of Euros 267.1 million in the prior year. The result for this year includes the impairment losson the investment in Olimpia S.p.A. (Euros 2,110 million) offset by the gain realized on the sale of a38.9 percent stake in Pirelli Tyre (Euros 416.4 million), the sale of the investment in Capitalia S.p.A(Euros 215 million) and the valuation of the investment in Olimpia S.p.A. using the equity method fora positive Euros 170.0 million (Euros 152.5 million in 2005).The item also includes the results of the companies in the real estate sector valued by the equitymethod (Euros 105.6 million) and dividends collected (Euros 67.1 million).

Income (loss)

On a comparable consolidation basis, the consolidated net result from continuing operations in 2006is a loss of Euros 1,018.8 million compared to income of Euros 349.1 million in the prior year.The total result in 2006 is a loss of Euros 1,048.8 million, including a loss of Euros 30 million fromdiscontinued operations compared to total income in 2005 of Euros 398.9 million including incomefrom discontinued operations of Euros 49.8 million.The loss attributable to the equity holders of Pirelli & C. S.p.A. is Euros 1,167.4 million compared toincome of Euros 327.4 million in 2005.

Equity

Consolidated equity went from Euros 5,613.8 million at December 31, 2005 to Euros 4,686.6 million atDecember 31, 2006. The change in equity can be summarized as follows:

(in millions of euros)Translation differences (96.9)Income/(Loss) for the year (1,048.8)Dividends to third parties paid by: (162.7)- Pirelli & C. S.p.A. (113.7)- Pirelli & C. Real Estate S.p.A. (36.6)- Other Group companies (12.4)Exercise of Pirelli & C. Real Estate S.p.A. stock options 30.8Pirelli & C. Real Estate S.p.A. treasury share purchases/sales 48.5Fair value adjustment of available-for-sale financial assets 24.0Net actuarial gains (losses) on employee benefits 44.0Exercise of warrants 2003/2006 26.8Change in Olimpia valuation 41.0Pirelli Tyre stake purchased by third parties with a private placement 295.0(Income)/expenses from fair value adjustment of financial assets recognized in income (127.5)Acquisition of Pirelli Tyre stake from third parties (7.1)Capital increase by minority interest 7.0Other changes (1.3)

(927.2)

24




The equity attributable to the equity holders of Pirelli & C. S.p.A. at December 31, 2006 is equal toEuros 3,879.6 million (Euros 0.723 per share) compared to Euros 5,204.9 million at December 31,2005 (Euros 0.979 per share).

Net financial position

The net financial position of the Group went from a debt position of Euros 1,177.4 million atDecember 31, 2005 to a debt position of Euros 1,979.6 million at December 31, 2006.In detail, the change can be explained by the following analysis of cash flows:

(in millions of euros)Cash flows used in ordinary activities 103.5Exercise of warrants 2003/2006 27.3Purchase of Telecom Italia shares (201.0)Purchase of Capitalia shares (38.2)Partial sale of F.C. Internazionale Milano shares 13.5Outlay to Hopa (497.7)Net proceeds from sale of 38.9% stake in Pirelli Tyre 715.8 Proceeds from sale of Capitalia shares 332.9Outlay for banks put (1,040.0)Pirelli Real Estate transaction in Germany (140.0)Sale of Pirelli Real Estate treasury shares 84.4Dividends paid (162.7)

Change in net financial position (802.2)

Employees

At December 31, 2006, there are 28,617 employees compared to 26,827 at December 31, 2005, with anincrease of 1,790 (including 377 with temporary contracts) due primarily to the expansion ofactivities in the tyres and real estate sectors.

Capital expenditures

Capital expenditures total Euros 255 million. The ratio of capitalexpenditures to depreciation is 1.3.Capital expenditures are principally concentrated in the Tyres Sectorand directed to the development of innovative processes, theincrease in production capacity for the premium tyre range and thelaunch of new products.

R&D expenditures

R&D expenditures borne by the group and completely expensed toincome went from Euros 174 million in 2005 to Euros 171 million in2006. R&D as a percentage of net sales is 3.5 percent.

25


Capital expenditures by the Groupin 2006 were mainly concentratedin the tyre sector to increase productioncapacity



Pirelli Labs

During 2006, Pirelli Labs, the group’s pool of technologicalexcellence, continued its activities in the sphere of research oninnovative materials and optical technologies fortelecommunications. As part of the development of its activities, itsigned partnership agreements with two Italian research centers:ENEA and the Istituto sull’Inquinamento Atmosferico of the CNR(CNR-IIA).Pirelli Labs has initiated three advanced research projects withENEA, Ente per le Nuove Tecnologie l’Energia e l’Ambiente, in thefield of renewable energy sources and sustainable development aspart of a framework agreement over a five-year period.The projects involve research on the concentrator photovoltaic power system, a new generation ofsensors for monitoring the environment, and groundwork research in the field of cold fusion.With regard to photovoltaic systems, one of the most interesting areas is the development of aninnovative photovoltaic system. Taking the Phocus technology previously developed by ENEA as abasis, they will develop a prototype of a high- concentration photovoltaic system using a Fresnel lensand a solar tracker, rated at a total of 1 kW. This system, created within the context of an activity ofinterest to Telecom Italia, together with two conventional silicon crystal systems, each rated at 1 kWand only one of which has a solar tracker, will be installed at the Telecom Italia exchange at NaplesBarre. A monitoring system will make it possible to detect remotely and continuously the electricalenergy produced according to the prevailing weather conditions and will allow an objectivecomparison to be made between the different systems being used.Within the sphere of sustainable development, the aim of the partnership is to study a newgeneration of smart, remote-controlled sensors with low consumption to monitor air pollution.When spread over a wide area, these sensors should be able to provide data in real time through awireless connection with low running costs.With regard to research in the field of cold fusion, the partnersintend to clarify controversial aspects of this technology witha view to developing solutions for producing energy in the future.Along with the Istituto sull’Inquinamento Atmosferico of the CNR(CNR-IIA), Pirelli Labs has presented a project which involvesmonitoring air quality and levels of electromagnetic and noisepollution in real time, to be conducted in Parma until May 2007.This new philosophy of monitoring air and environmental pollutionhopes to offer solutions which are complementary to theconventional ones, extremely flexible and simple to use, as well asbeing cheap and producing high-quality results. In this way, it willbe possible to increase the number of monitoring points and obtaina more representative picture by supplying those responsible witheffective tools for monitoring environmental pollution in townsand cities.Cooperation continued with partners in Italy and abroad, such asGeorgia Tech University (in Georgia, U.S.A.) and the MilanPolitecnico University, on joint projects.

26


Monitoring of air quality by Pirelli Labsand CNR is an ongoing project atParma

Pirelli Labs and ENEA teamed up in 2006to start three advanced research projectsin the field of renewable energy andsustainable development

IntroductionThe Group2006 operating andfinancialMajor events in 2006Group consolidation

A Pirelli LabsSignificant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocumentsPirelli TyrePirelli BroadbandSolutionsPirelli & C. Real EstatePirelli & C. AmbienteInformation systemsProforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plansCorporate GovernancePirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

27

Pirelli Labs Materials Innovation

In 2006, the main activities focused, on the one hand, on supportingthe businesses of the group, and, on the other, on developing specialprojects, such as Sensor Networks and Fuel Cells.Cooperation continued with Telecom Italia on the developmentof joint projects.Research work for Pirelli Tyre focused on using nanocomposite-based compounds with a polymeric matrix with the aim ofexploiting their excellent physical and mechanical propertiesand consolidating their use in special types of compounds.A systematic study has begun to examine their use in differenttypes of polymer compounds made to function with polarmolecules.Cooperation with the Pirelli Real Estate Group has been expanded,concentrating on projects associated with the concept of“sustainable building”, with particular emphasis on buildingmaterials and saving energy.As far as products/systems for monitoring traffic flows areconcerned, work on sensors and management control systems,both developed in-house, have reached the engineering stage.In addition, in collaboration with Pirelli Broadband Solutions,testing has begun in the laboratory and in the field, and moveshave been made towards production on an industrial scale, whichshould result in commercial products/systems being available in2007. Through the consolidated relationship with Telecom Italia,contacts have also begun preliminary to the development of themarket and the exploitation of these systems commercially.With regard to the products/systems for monitoring the environment,various joint testing projects have successfully been concluded with public authorities. In addition,an important field testing phase, financed by the Ministry for the Environment, with the collaborationof CNR, has begun in the city of Parma. Furthermore, the testing of the instrumentation required bythe national state body responsible for homologation was successfully completed. In parallel, thedevelopment and engineering of products continued, while an assessment was made of potentialpartners to produce the sensors developed on a large scale. The partnership continued with TelecomItalia and Sartec, a well-established player in the sector of environmental monitoring, with regard todefining and developing the market.In the sector of Distributed Sensor Networks (DSN), in 2006 work continued on the optimization anddevelopment of the product, on the level of general purpose platform and specific applications formonitoring the environment and traffic flow. Furthermore, protection of the product was consolidatedat the level of intellectual property, with the registration of three new patent applications.In Fuel Cells research, activities focused on the development of materials for highly-efficientcomponents for polymeric cells fed with direct methanol (DMFC) and for Solid Oxide Fuel Cells(SOFC).In the sector of DMFC cells, collaboration has begun with DuPont, the world’s leading player in thefield of materials for fuel cell components. The work focuses on the development and optimization ofthe polymer electrolyte membranes (PEM) patented by Pirelli according to different specificapplications. They will mainly be used in batteries for charging portable electronic systems. Duringthese first six months of collaboration with DuPont, considerable progress has been made in theperformance of the membranes, which is also viewed positively by our partner in the project.In the field of SOFC cells, collaboration continued with the prestigious Canadian research body, theAlberta Research Council (ARC). The aim is to combine the technology for miniaturizing the tubular


Research into nanocompositeelastomer-based compounds is oneof the activities of Pirelli Labs-MaterialsInnovation

Cooperation between Pirelli Labs andPirelli RE is basically centered on thedevelopment of innovative materials for“sustainable building”



fuel cells developed by ARC with innovative materials for direct fueloxidation developed by Pirelli Labs. Various powder compositionshave been developed which can withstand direct oxidation of fuelssuch as methane, methanol and methane-and-hydrogen compoundswithout incurring any damage.Various quantities of the above-mentioned powder were supplied tothe ARC for optimization with their own microcells.Collaboration with Telecom Italia continued, generating resultswhich are sure to be of interest in spheres of activity relating to thestudy of innovative materials used in mobile devices for applicationsin telecommunications.In particular, a new category of dielectric antenna has been developedfor Wi-Fi applications. The core of the antenna consists of dielectricpolymeric composites filled with dielectric ceramic powder. Comparedto the normal outdoor antennas of devices currently on the market,this new type of antenna performs as well, and, in some cases, better, their production costs arecomparable and more importantly, they are integrated with the apparatus of which they are part, thusproviding the option of designing devices with innovative esthetic effects. This consideration becomeseven more important with the growing number of antennas required by the new Wi-Fi devices. The firstapplication of this antenna, presented at the Broadband World Forum held in Paris in October 2006, isan ADSL Wi-Fi modem which has aroused the interest of several operators in the sector.Other devices currently being researched include innovative devices, based on ceramic material, thatextend the capacity and coverage of radio base stations in mobile networks. Various prototypes ofdevices that are able to change the field phase are currently available and can operate at differentpower levels matching a wide application field. Pirelli Labs has produced iron-electronics samples inwhich it is possible to alter some physical properties making the devices applicable to varioussectors of the electronics industry.In the sector of more long-term research, work began successfully in the sphere of the two Europeanprojects QAP and SINPHONIA. In the laboratory, the feasibility of innovative single photon countingsystems, necessary for implementing quantum optical networks was demonstrated. In addition, workcontinued in the project to develop a new type of solar neutrino detector. In collaboration withENEA, joint development work began, with promising preliminary results, in the sector ofphenomena of energy generation in palladium hydride (cold fusion).Finally, the Telemedicina Project was presented at Telbios with the aim of identifying a businessmodel. This will be based mainly on marketing the prototype of the recently developed, veryhigh-resolution remote electrocardiograph.

Pirelli Labs Optical Innovation

The activities of the laboratories focused on telecommunications applications in three main spheres:photonics nanotechnologies, optical systems and network access devices.In the field of photonics nanotechnologies, the tunable laser was qualified according to the Telcordiastandard for application in optical transport networks, both in cities and long-distance networks. Anew version of the laser is being developed which will be cheaper to produce and more competitivein terms of power consumption. This laser will be available for marketing through Pirelli BroadbandSolutions by the second quarter of 2007.Work began on the development of a new integrated, optical tunable laser that can be directlymodulated and will feature higher performance, a smaller footprint, less power consumption, andlower cost than tunable lasers currently available in the marketplace today.Work continues on the development of the integrated optical router (OADM) for which the first batchof samples is expected to be ready in the second quarter of 2007.

28


In the field of Materials Innovations,Pirelli Labs has developed dielectricantenna integrated in Wi-Fi equipment



With the aim of exploiting integrated devices, development workhas begun on opto-electronic modules which perform the samefunctions as optical systems.In particular, a MSA standard transceiver module is being developedthat can be mounted on an electronic plate. It uses the tunablelaser and a dispersion compensator based on nanotechnologies.This transceiver will allow installers of apparatus to make 10 Gbit/soptical links without having to distribute dispersion compensatorsapproximately every 350 km, thus significantly reducing the cost oftransport infrastructures in metropolitan areas. The product willbecome available in 2007.A 10 Gbit/s transceiver module is being developed with connectionaccording to the XFP standard which, thanks to a special opticalfilter, makes it possible to achieve performance which is significantlybetter than current products in terms of tolerance of chromatic dispersion.In the sphere of optical systems, work continued to develop Coarse Wavelength DivisionMultiplexing (CWDM) systems, which have found broad application in the transport of voice, dataand video on regional networks in Europe and the U.S.A.. New work has started based on the sameplatform for a new generation of products called Light WDM which integrates the functions ofCoarse WDM and Dense WDM systems and exploits innovative modules based on nanotechnologiesin an optimum way.In the sphere of devices for network access, the qualification of the ADSL2+ gateway was completedat Telecom Italia with access speeds of up to 20 Mbit/s and also integrates high-speed Wi-Fifunctions.Work began to develop the new generation of gateway based on VDSL2 technology.The new gateway will allow access speeds of up to 100 Mbit/s and will constitute the usertermination of the new broadband network being developed by Europe’s leading operators.In the area of home networking, the qualification process was completed at Telecom Italia for a newgeneration product for residential diffusion on power lines of telecommunications signals with atransmission capacity of up to approximately 100 Mbit/s.Development work was completed on a highly sensitive transceiver for Wi-Fi transmissions usingMIMO technology, with the aim of achieving reliable wirelessbroadcasting of video signals using real-time streaming from theaccess terminal to the set-top-box.Research continued to develop a high capacity (2.5 Gbit/s) wirelesssolution with radio broadcasts using millimetric wave frequencies(60 GHz) in collaboration with Georgia Tech University (Georgia,U.S.A.).The development of a new generation of set-top-box has beencompleted with highly integrated electronics. The new device will bepre-set to cope with the most advanced video codes and tobroadcast high-definition television. The integration of software tomanage the content distribution system which will be adopted by thelargest world operators is in the process of completion. This productwill be distributed by Telecom Italia in 2007.

29


Development of a new-generationset-top-box with highly integratedelectronics for high-definition TV wascompleted in 2006

In the field of Optical Innovation,development began on opto-electronicmodules – such as the MSA transceiver –able to perform the main functions ofoptical systems



Significant events subsequent to the end ofthe year

• On January 9, 2007, Pirelli & C. S.p.A. and QuattroduedueHolding B.V. (the controlling shareholder of Intek S.p.A.), with aview to the project for the merger of Gim S.p.A. in Intek S.p.A.and in execution of the provisions established by the new codicilNo. 1 among the members of the Gim Shareholders’ Agreement,signed a put&call agreement relating to 14,923,526 Gim S.p.A.ordinary shares held by Pirelli & C. S.p.A., equal to approximately7.04 percent of Gim S.p.A. ordinary share capital.The understanding provides that, starting from the date theindicated merger comes into effect, Pirelli and Quattroduedue willhave, respectively, the right to sell – up to the limits of the tenderoffer – and purchase the entire investment acquired by Pirelli as aresult of the merger for consideration of Euros 13.1 million.The agreement is subject to the merger becoming effective andcan be carried out by Quattroduedue Holding B.V. in more thanone tranche by and not after May 31, 2008. Subsequent to thatdate, should Quattroduedue Holding B.V. not yet have exercisedthe option on the entire investment, Pirelli & C. S.p.A. will havethe right to sell such shares to third parties, with the possiblepayment of compensation by Quattroduedue Holding B.V. if thereis a negative difference compared to the agreed price.

• On January 10, 2007, Pirelli Real Estate, in execution of thebinding agreement signed on October 9, 2006, purchasedapproximately 97 percent of Deutsche Grundvermögen AG(DGAG), one of the most important real estate companies inGermany with offices in Hamburg and Kiel. The purchase price,subject to a price adjustment on the basis of the 2006 financialstatements, was set at approximately Euros 465 million for 100percent of DGAG. As a result of additional purchases on January12, 2007, Pirelli Real Estate increased its percentage ownership tomore than 99 percent. In keeping with the Pirelli Real Estatebusiness model, DGAG will be transformed into a platform of realestate investments, asset management and services. By the end of2007, DGAG’s residential portfolio worth approximately Euros1,040 million will be transferred to the joint venture between PirelliReal Estate (35 percent) and the real estate investment funds ofRREEF (65 percent), the division of Deutsche Bank which dealswith real estate investments, while the retail and office portfolioworth approximately Euros 275 million will be transferred to thejoint venture between Pirelli Real Estate (30 percent) and the realestate investment funds of Morgan Stanley (MSREF) (70 percent).Other assets and the assets under management and services willremain with Pirelli & C. Real Estate Deutschland Gmbh.

• On January 17, 2007, Pirelli & C. S.p.A. announced that none ofthe parties in the Pirelli & C. S.p.A. shareholders’ agreementindicated the desire to withdraw from the pact within thecontractually established expiration date of January 15, 2007.The pact will thus remain in effect, with the same composition,until the new expiration date of April 15, 2010.

30


The Deutsche Grundvermorgen AG officein Hamburg, an important real estatecompany acquired by Pirelli RE in 2007

IntroductionThe Group2006 operating andfinancialMajor events in 2006Group consolidationPirelli Labs

A Significant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocumentsPirelli TyrePirelli BroadbandSolutionsPirelli & C. Real EstatePirelli & C. AmbienteInformation systemsProforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plansCorporate GovernancePirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

• On January 22, 2007, Pirelli & C. Ambiente Eco Technology S.p.A.,which also operates in the sector of technologies for sustainabledevelopment, and LiqTech A/S, a Danish company which hasoperated for years in the sector of silicon carbide filters for theretrofit market, signed an agreement to conduct joint researchinto silicon carbide filters. The results generated by the research will be jointly owned bythe two companies but Pirelli will have the exclusive rights toexploit them in Europe, Russia and the former Soviet SocialistRepublics, Brazil and China. Similarly, LiqTech will have theexclusive rights to exploit the results of the research in theU.S.A., Mexico, South Korea, India and Japan. Furthermore,under the agreement, LiqTech will support Pirelli & C. AmbienteEco Technology S.p.A in the development of the productiontechnology for mass-producing silicon carbide anti-particulatefilters which will first be used on diesel engines.The results generated by this development work will be theexclusive property of Pirelli & C. Ambiente Eco Technology S.p.A.and will be implemented in the factory which the company willstart to build in Romania in January 2007 to produce anti-particulatefilters for the original equipment market. As already mentioned,the factory will become operational in the second half of 2008 andwill have a production capacity of more than 1,300 tons of siliconcarbide filters a year.

• On January 30, 2007, the board of directors of Pirelli & C. RealEstate SGR S.p.A. approved the management accounts of TeclaFondo Uffici, Berenice Fondo Uffici and Olinda Fondo Shops atDecember 31, 2006, confirming returns that were higher than thetargets indicated in the placement also for the year 2006.

• On February 12, 2007, Pirelli Tyre S.p.A. made it known that it hadsuccessfully concluded the syndication of a five-yearmulticurrency revolving credit line announced to the market onJanuary 8, 2007. The contract was signed by the company with themandated lead arrangers BNP Paribas and Banca Monte deiPaschi di Siena, and a pool of leading Italian and internationalbanks (Akbank, Bank of America, Banca Carige, Banco do Brasil,Banca Popolare dell’Emilia Romagna, Banco Santander CentralHispano, ItauEuropa, Mizuho, Natixis and Royal Bank of Canada).In view of the high number of commitments, the initial amount ofEuros 500 million was increased to Euros 675 million. The loanbears interest at an initial rate equal to the Euribor + 40 basispoints. The purpose of the transaction is to allow Pirelli Tyre toimprove its financial structure while at the same time increasingits flexibility.

• On February 12, 2007, a land area was purchased in the city ofPortogruaro for approximately Euros 8 million for the EastgatePark project. This is the largest integrated industrial park in theeast part of the northeast of the country on which constructionbegan in the early months of 2006. On February 13, 2007,

31


Pirelli Ambiente is building a plantin Romania for the manufacture ofanti-particulate silicon carbide filtersslated for the original equipment of dieselengines

Pirelli RE: the Eastgate Park project, thelargest industrial park in the east part ofthe northeast of the country is located inthe city of Portogruaro



“Mission Zero”, starring Uma Thurman, is the second PirelliFilm released on thewebsite www.pirellifilm.com since February 2007

following the preliminary agreement signed on December 29,2006, Fondo Spazio Industrial also purchased two additionalbuildings for industrial use situated in Pordenone and Belluno fora price of Euros 22 million.

• On February 27, 2007, the world council of the FIA acceptedPirelli’s offer to supply tyres for the World Rally Championship(WRC) over the three-year period 2008-2010, appreciating notonly the product and Pirelli’s capacity for technologicalinnovation, but also its aim to seek out and encourage youngtalent and to promote national championships. In particular, oneof the reasons why the FIA chose Pirelli, is its century-longcommitment to motor racing, and car rallies in particular. Pirelli’swinning of the bid to supply the WRC was the second victory inthe space of a few weeks. At the end of January, the Grand Amseries, the most exciting championship for prototypes in theUnited States and one of the most popular in America, decided toadopt the Pirelli PZero for the three-year period 2008-2010.

32


For the three years 2008-2010, Pirelli willbe the sole supplier of tyres for the WorldRally Championship



Outlook for the current year

The strategy of focusing on the segments with high added value and the positive trend of the corebusiness allow the Pirelli & C. S.p.A. Group to forecast a further improvement in results for 2007,unless external extraordinary events occur which cannot be foreseen at this time.

In particular, in industrial activities, Pirelli Tyre again expects to report higher sales than the marketaverage, partly as a result of focusing on the premium segments in the Consumer area and in rapidlydeveloping markets in the Industrial area. The improvement in the price/mix ratio should compensatethe factors of cost and allow a higher operating result than 2006, unless events intervene of anonrecurring nature.

As for the prospects of Pirelli Real Estate in 2007, a further growth is expected in the operatingresult inclusive of the share of earnings (losses) of equity investments, in line with the 2006-2008three-year business plan.

With regard to the start-ups, Pirelli Broadband Solutions forecasts a further increase in sales in2007, concentrated especially in the second half of the year, thanks to the completion of the portfolioof access solutions and an ever-greater contribution from the photonics business. In 2007, there willagain be significant investments in research and production to develop new products in this area.

Pirelli Ambiente expects to consolidate the growth trend in sales.

With regard to the investment in Olimpia S.p.A., the board of directors has given the Chairman amandate to explore all the possible options, not excluding the divestiture of the investment, with theaim of achieving the best strategic appreciation of the asset in the interest of all the shareholders.

Reconciliation of consolidated equity

The reconciliation between the equity of the parent, Pirelli & C. S.p.A., and the consolidated equityattributable to the equity holders of the parent is as follows:

(in millions of euros)Share Reserves Income Total

capital (loss)Equity - Pirelli & C. S.p.A. at December 31, 2006 2,790 1,735 (1,642) 2,882Results for the year of consolidated companies (pre-consolidation adjustments) 846 846Capital and reserves of consolidated companies (pre-consolidation adjustments) 1,978 1,978Consolidation adjustments:- carrying amount of investments in consolidated companies (1,356) (1,356)- infragroup dividends 186 (186) - - other (285) (185) (471)Consolidated equity - group at December 31, 2006 2,790 2,257 (1,167) 3,880

Programmatic security documents

In compliance with the Legislative Decree of June 30, 2003 no. 196, attachement B, paragraph 26,the Pirelli Group has already provided to update the Programmatic Security Documents for theyear 2006.

33


IntroductionThe Group2006 operating andfinancialMajor events in 2006Group consolidationPirelli LabsSignificant eventssubsequent to the endof the year

A Outlook for the currentyear

A Reconciliation ofconsolidated equity

A Programmatic securitydocumentsPirelli TyrePirelli BroadbandSolutionsPirelli & C. Real EstatePirelli & C. AmbienteInformation systemsProforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plansCorporate GovernancePirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

Pirelli TyreThe highlights of the consolidated financial statements for the yearending December 31, 2006 can be summarized as follows:

(in millions of euros)2006 2005

Net sales 3,949.5 3,632.9Gross operating profit 533.7 518.1% of net sales 13.5% 14.3%Operating profit 342.3 328.8% of net sales 8.7% (1) 9.1%Earnings (losses) from investments (2.4) (1.3)Operating profit (loss) incl. earnings(losses) from investments 339.9 327.5Financial income (expenses) (54.1) (32.1)Income taxes (86.5) (97.0)Income 199.3 198.4 % of net sales 5.0% 5.5%Net financial (liquidity)/debt position 601.5 237.4 Capital expenditures 224 208 R&D expenditures 147 146 Employees (number at year-end) 25,169 23,673 Factories (number) 24 24 (1) 8.9% excluding IPO costs.

Net sales

Net sales in 2006 amount to Euros 3,949.5 million, with an increase of8.7 percent compared to the prior year. The trend is positive in termsof volumes and prices/mix which record increases of 3.9 percent and3.1 percent, respectively. The foreign exchange difference alsoproduced a positive effect on net sales (+1.7 percent).The distribution of net sales is as follows:

Geographical Area 2006 2005Italy 11% 13%Other European countries 40% 41%North America 8% 8%South America 26% 25%Africa/Asia/Pacific 15% 13%

Product Category 2006 2005Car tyres 62% 62%Truck tyres 28% 28%Motorcycle tyres 8% 8%Steelcord/Other tyres 2% 2%

Gross operating profit

Gross operating profit is Euros 533.7 million (+3 percent comparedto 2005 and equal to 13.5 percent of net sales) includingnonrecurring costs of Euros 7.4 million incurred for the IPOproject. The gross operating profit from ordinary operations isEuros 541.1 million, with an increase of 4.4 percent compared toEuros 518.1 million in 2005.

Operating profit

Operating profit, although influenced by nonrecurring costsincurred for the project to list Pirelli Tyre S.p.A. (Euros 7.4million), amounts to Euros 342.3 million (8.7 percent of net sales).

34


SOUTH AMERICAITALY

NORTH AMERICA OTHER EUROPEANCOUNTRIES

AFRICAASIAPACIFIC

MOTORCYCLE TYRES

TRUCK TYRES CAR TYRES

STEELCORD/OTHER TYRES

Tyres: 2006 sales by geographical areaand product category.

IntroductionThe Group2006 operating andfinancialMajor events in 2006Group consolidationPirelli LabsSignificant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocuments

A Pirelli TyrePirelli BroadbandSolutionsPirelli & C. Real EstatePirelli & C. AmbienteInformation systemsProforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plansCorporate GovernancePirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

This is a growth of 4.1 percent compared to 2005 in which the operating profit amounted toEuros 328.8 million with a margin on net sales of 9.1 percent.The positive impact associated with the growth of sales, mix and efficiencies, in addition to thepositive contribution by exchange rates, more than compensated the increase in production factorsand, in particular, the increase in raw material costs (Euros 111 million) which is the main cause ofthe decline in the profit margin, besides the effect of the start-up of the truck tyre factory in China.

Details of the positive change of Euros 13.5 million in the operating profit compared to 2005 can besummarized as follows (in millions of euros):

Operating profit 2005 328.8Foreign exchange effect 11.8Prices/mix 24.5Volumes 60.8Production factors per unit cost (136.3)Efficiencies 26.3Depreciation and other * 26.4

13.5Operating profit 2006 342.3(*) Includes the reduction of costs for sports activities, marketing expenses, depreciation, amortization and other.

Income

Income in 2006 is Euros 199.3 million (after financial expenses and the earnings (losses) frominvestments equal to Euros 56.5 million and income tax expenses of Euros 86.5 million) comparedto income of Euros 198.4 million in 2005 (after financial expenses and the earnings (losses) frominvestments equal to Euros 33.4 million and income tax expenses of Euros 97 million). With regard tofinancial expenses, it should stressed that as a result of the corporate reorganization carried outduring the first quarter, the net debt of Pirelli Tyre increased by Euros 406 million.


The net financial position at December 31, 2006 is a net debt position of Euros 601.5 million comparedto Euros 237.4 million at December 31, 2005. The increase is connected with the aforementionedreorganization which was partially compensated by the cash generated by ordinary activities.

Employees

There are 25,169 employees at December 31, 2006 including 2,532 employees with temporarycontracts and 733 temp employees.Compared to December 31, 2005, there was an increase of 181 management and permanent staff duemostly to the hiring of people for the new investment areas in China and Romania, and an increaseof 87 people with temporary contracts.As regards the blue-collar work force, the number increased by 1,228 (of whom 1,008 are inpermanent positions and 220 with temporary contracts and temp work) due basically to the hiring ofpeople in Brazil mostly in the factories in Gravataì for the manufacture of All Steel Truck tyres (+94),in Feira de Santana due to higher Car volumes (+200), in Campinas as a result of the change in thework plan (+169), in Romania (+396), in China (+252).At December 31, 2006, the work force (excluding employees with temporary contracts) may beanalyzed as follows:

2006 2005Senior executives 0.9% 0.9%Staff 21.1% 21.5%Blue-collar 78.0% 77.6%

35




The organizational development activities during 2006 involved both the entrenched areas ofinternational presence by Pirelli Tyre, and the new operations in China and Romania.

In 2006, a worldwide project was launched to map the skills and competencies of the key resourcesin the industrial function and in the quality function. The aim is to create a common base from whichto start planning and implementing special training courses as well as recompense and developmentactions according to a common rationale. With reference to the sales project called “Running theMarket” launched in the prior year, 2006 was a year devoted to designing and distributing trainingpackages, with the aim of developing expertise and role skills through technical, professional andmanagerial training courses.

As for the investment in China, within the framework of the China Intercultural Managementproject, a series of seminars was held with the aim of acquiring greater knowledge of the Chinesemacro-economic situation and learning about cultural differences between Europe and China.A Development Center was created for the purpose of assessing the expertise of local managementand defining training and development plans.

With reference to the new area of investment, Romania, training involved both factory workers,who attended theoretical courses and on-the-job training in European factories, and staff, whoattended courses on corporate values, the Code of Ethics and cultural differences.Within the sphere of research, selection and employer branding, in 2006, Pirelli Tyre held a talentattraction initiative called Project Recruiting Day on the test-track at Vizzola. On this occasion,70 undergraduates from the most prestigious universities had the opportunity to follow a specialdriving lesson on safety during the first part of the day, and later participated in a first part of aselection phase which was organized on the basis of an innovative team game.

With regard to Industrial Relations, the economic part of the collective bargaining labor contractswas renewed in Italy, the U.K., Turkey, Brazil and Argentina with the aim of keeping labor costs inline with local inflation.In Brazil in particular, agreements were stipulated among the parties, in order to optimize the workschedules used in factories.

36


A picture of Pirelli employees in 1905 in front of the first factory at Ponte Seveso. Today, more than 25,000 people make up the Group’s work force



Capital expenditures

During 2006, capital expenditures in fixed assets amounted toEuros 224 million, equal to 1.17 percent of depreciation and5.7 percent of net sales (compared to 1.10 percent of depreciationand 5.7 percent of net sales in 2005).Capital expenditures in factories represent 93 percent of the total.This is in line with the group’s strategy and market demand.The capital investments were employed in the development ofinnovative processes, expansion of production capacity, especially inlow-cost areas, increasing high-performance production andlaunching new products.

Car: In the sphere of innovative processes, the production capacity of the MIRS (Modular IntegratedRobotized System) process was increased in Germany, the U.S.A. and the U.K., by optimizingexisting lines. With regard to traditional processes, conversion of the production capacity of“high-performance” products and the revamping of existing machinery continued.With the aim of meeting increased market demand by reducing production costs, a greater boost wasgiven to increasing production in geographical areas with low costs. In particular, a new factory wasopened at Slatina in Romania and building work began on a new factory at Yanzhou in China. Workis continuing to augment the capacity of the factory at Bahia (Brazil) where semi-automaticprocesses are being installed.

Industrial vehicles: The new All Steel plant has been completed at Gravataì in Brazil and the newplant at Yanzhou in China is now fully operational.In the field of innovative processes, production continued to increase at the factory at SettimoTorinese for the new Amaranto product line using the innovative SATT (Spiral Advanced Technologyfor Truck) technology derived from MIRS technology. The extension of this production processbegan in the plants at Izmit in Turkey and at S. Andrè in Brazil.Furthermore, the group continues to follow the strategy of renewing the product line-up andextending programs for improving efficiency and quality in all the factories.

Steelcord: the expansion plan continued to move forward, especially at the new plant at Slatina inRomania and in Brazil, whereas, in Italy, efforts were concentrated on researching and developingprototypes for new products and materials.

Research & Development expenditures

In 2006, R&D expenditures amount to Euros 147 million, equal to 3.7percent of net sales, and are completely expensed to income.Traditionally this activity has focused on the development of newhigh-performance products (e.g. Run-Flat, SUV and motorcycletyres) by exploiting technological components and very advancedknow-how which are the result of intensive research in the areas ofmaterials, design, profiles, tread patterns and processes.

To sustain improvement and innovation of the product portfolio,research is under way to find innovative solutions through the studyand application of new types of polymers and nanotechnologies.Applying these new technologies have made it possible to increasethe level of product performance and, on the other hand, it openedup the possibility of using new types of materials.

37


Productivity of the MIRS manufacturingprocess was increased at the Breuberg(Germany) tyre factory

2006 Pirelli Tyre capital expenditurestraditionally focused on the most advancedhigh-range products



In 2006, Pirelli’s leading role as a supplier of Original Equipmenton a global scale was confirmed, judging by the ever-greaterconsensus in the high technological standard of Pirelli products.At the Detroit Motor Show, 23 leading car manufacturers exhibitedmodels fitted with Pirelli tyres of the PZero, Run Flat Eufori@and Scorpion range. At the Geneva International Motor Show,very-high-performance Pirelli tyres equipped various prototypes(the Isotta-Fraschini, the Aston Martin Rapide and the LamborghiniMiura, and the off-road Fiat “Oltre”, exhibited with Pirelli Truck PS22tyres). What’s more, at its own stand, Pirelli presented the innovativeK-Pressure Optic system for the active control of tyre pressure.

In terms of day-by-day development, close collaboration continueswith carmakers. This resulted in products of the PZero range beingfitted on the latest models of many leading car manufacturers, bothItalian companies like Ferrari, Lamborghini, Maserati and AlfaRomeo (at the Paris Motor Show with the new Alfa Romeo 8CCompetizione), and foreign companies (like Porsche, Bentley,Audi, Aston Martin, Volvo and Jaguar). It should be emphasizedthat, with the very low profile PZero Corsa System tyres, which arederived from racing models and guarantee excellent performancein terms of road-holding on curves, with a good acceleration andbraking capacity, whether on dry or wet surfaces or on the racetrack, Pirelli’s position in the top car segment was strengthenedwith important homologations on Lamborghini models(the Gallardo Spyder and the new Murciélago LP640) and as a“sport tyre option” on the Aston Martin V8 Vantage. The PZerorange was also the center of attention at the 2006 SEMA Show, themost important tyre show in the United States. The star of theshow was the Scorpion Zero Asimmetrico in the 405/25R24 size(the widest tyre on the market in the SUV segment and scheduledfor production at the Pirelli Tyre North American MIRS plant),presented at SEMA on a Dodge RAM 1500.The collaboration agreement was renewed with Maserati andFerrari, both in the racing sphere (GT1 and GT2), and to researchnew products destined for their cars.

In 2006, Pirelli won the international FIA GT1 and GT2 championshipswith the Ferrari team and drivers, and the European Le Mans SeriesGT2 category with Porsche. In addition, Stèphane Sarrazin, driving anAston Martin with Pirelli tyres won the title of Best Driver of the Year.In the tests conducted by the European specialized press, in 2006,Pirelli again achieved excellent results in terms of performance,both in the Summer segment with the PZero Nero, P6, P7 and theScorpion Zero, and in the Winter segment with all the tyres of therange (Snowsport, Snowcontrol, Sottozero and the Scorpion Ice &Snow). These were also praised for their comfort and theircontribution to safe driving.

As for the SUV segment, in Tunisia in May, Pirelli presented its latestproduct for 4x4 vehicles (SUVs and pick-ups), the new Scorpion ATRproduct line. This special product is the result of developmentconducted in cooperation with the most prestigious automotive

38


Pirelli Scorpion ATR is the new product linefor SUVs, pick-ups and 4x4 off-roadvehicles

The cooperation agreement with Ferrariand Maserati for Granturismo racingactivities was renewed

Pirelli, always the protagonist at Americanautomobile shows thanks to the ScorpionZero Asimmetrico, offered in sizes up to24-inchs



companies, combined with Pirelli’s long experience in the segment. It can be used in many differentapplications because of its special characteristics, and performs safely at a very high level, both off-road and on asphalt. The tyre will be distributed on worldwide markets (North and South America,Europe, Africa and Asia): a truly global product.In September, an important acknowledgement arrived from the United States with the publication ofthe JD Power and Associates 2006 OE Tyre Satisfaction Study. This survey was conducted byconsulting 23,000 American consumers about tyres in the Mass Market/Non-Luxury segment.Especially with the P6 Four Seasons, Pirelli was voted better than the average of the segment in all ofthe five factors considered (duration, road-holding, design, driver satisfaction and handling), obtainingthe highest marks for road-holding and design, and the final result of absolute best in the segment.

Tyre System and Vehicle Dynamics

Research and development work continues on systems forcontrolling correct tyre pressure. In fact marketing has begun of theK-Pressure Optic, an extremely simple device to install (it is merelyscrewed onto the valve instead of using a cap) and just as simple touse. If the tyre pressure is below the optimum, the end of the devicechanges color.The collaboration between Pirelli and Schrader Electronics, one ofthe leading electronics companies producing tyre-pressure detectionsystems for original equipment, has been made official and is nowoperational. Together, they intend to develop the Cyber Tyre Leansystem, an innovative device for detecting tyre pressure that isapplied directly onto the inside of the tyre and gives real-timeinformation about pressure, but also other useful information, such as the type of tyre and when itreaches the maximum load.Pirelli’s research group has also begun strategic collaboration with the University of California atBerkeley to develop sensors with wireless technology to be applied on tyres, with the aim of improvingvehicle performance and safety.Finally Pirelli acquired the patents of Leonardo Fioravanti with a view to developing the Cyber Tyre.

39


The Aston Martin DBR9 equipped by Pirelli was one of the revelations of the Fia Gt 2006 Championship

Marketing commenced for the K-PressureOptic device for controlling tyre pressure



Consumer market

The Consumer market includes the Car Business Unit, theMotorcycle Business Unit and some minor activities associatedwith them (distribution etc.).

In the Consumer market, which accounts for 69 percent of totalsales, 2006 recorded an increase in both revenues (+8 percent)and operating profit (+22 percent) compared to the prior year.Specifically, revenues amount to Euros 2,735 million and theoperating profit from ordinary operations is Euros 245.7 million.The improvement in the result can be attributed to the positivecontribution of sales variables and efficiencies, which more thancompensated the higher cost of raw materials.

Sales of Original Equipment for Cars remained fairly steadyin terms of volumes and reported an increase in value in Europeand the United States. This result was achieved thanks to theconsolidation of the positions acquired with the leadingEuropean car manufacturers, the growth of supply contracts tothe largest American car manufacturers (Ford, GM and DaimlerChrysler) and an improvement in the mix obtained throughconsolidated collaboration with the main manufacturers in thehigh-performance car segments (Alfa Romeo, Audi, Bentley,BMW, Ferrari, Maserati, Mercedes, Jaguar, Land Rover, Peugeot,Porsche, Saab, Volvo and VW).In the South American area, an increase in both volumesand sales was reported on all the Mercosur manufacturers(Fiat, Ford, GM, Honda, Peugeot, Toyota, VW), compared to theprior year.The homologation portfolio is growing: in addition to thewell-established products of the Pzero range (Rosso, Nero andCorsa) for the top cars, the P6 and P7 for Europe and SouthAmerica and the P6 Four Seasons for the NAFTA, there was apositive start to the homologation process for the new Pzero, theHero tyre, the new ultra high-performance tyre developed forsupercars and directly derived from Pirelli’s experience in racing.

At present, the PZero has obtained more than 15 homologationsas original equipment for the latest, most prestigious supercarsand is already being supplied for the Ferrari 599 GTB Fiorano,the Lamborghini Murciélago and Gallardo, the Audi R8 and S8,the Aston Martin DB9, the Maserati Quattroporte, the Jaguar XKand the Mercedes AMG. It will shortly be supplied for the AlfaRomeo 8C Competizione and the sportier models made byPorsche and BMW.During 2006, the positive trend of the SUV lines continued. Pirelli

40


The Lamborghini Gallardo is among thefirst and most prestigious homologationsfor P Zero the Hero

The new line of ultra-high performanceP Zero the Hero tyres was launched inspring 2007

The Scorpion ATR is supplied as originalequipment on the Ford F-150, the pick-upmost sold in the United States



is proud to have many homologations on high-performancevehicles. In particular, during the year, the range of the Scorpionline was further enhanced: the Scorpion STR, Scorpion Ice &Snow and Scorpion Zero were joined by the new Scorpion ATR,which is supplied as original equipment on the Ford F-150, themost successful pick-up vehicle in the United States.

Sales of Replacements for Cars ended 2006 with an increasecompared to the prior year in all the main areas of the market.In Europe, the market grew in terms of sales while volumesremained fairly steady. This situation can be attributed to thedifferent dynamics of the various segments of the market:positive in the high-performance range (Winter, SUV, HP/UHP andRun Flat), and negative in the other segments.In South America, there was growth both in volumes and sales,in line with the market trend, while in North America, Pirellireported growth despite the negative performance of the U.S.market.The technological leadership and excellent performance of Pirelliproducts continues to be confirmed by the positive results in allsegments in the comparative tests conducted by the specializedpress.In the Ultra High Performance segment, PZero Corsa, PZero Neroand PZero Rosso dominated the tests of specialized Europeanjournals, while in the High Performance segment, the P6 and P7tyres continue to have extremely positive assessments.In the Winter segment, the product tests were completelydominated by the products Sottozero, Snowsport and ScorpionIce & Snow. In 2006, the Citynet Winter Plus winter tyre for lightindustrial vehicles was added to the list of successes.

In the Motorcycle segment, sales of the Pirelli and Metzelerbrands increased in 2006, reporting growth that was higher thanthe average of the market, which reported a slight recoverycompared to the prior year.

In the Replacements channel for motorcycle tyres, the mostsignificant growth was reported in North and South America, inOceania and Japan, while growth in Europe was in line with themarket, where there was an improvement of the mix.There was a positive trend in the sales of the OriginalEquipment channel, especially in Brazil and Japan, withimportant homologations of the Pirelli Diablo Corsa on theYamaha YZF-R1 and the Ducati Hypermotard, and of the DragonSupercorsa PRO on the Ducati 1098 and the Triumph Daytona 675Triple naked; the Metzler Roadtec Z6 was homologated on theBMW R1200 R and the Yamaha MT 01.There were excellent results deriving from the success of new

41


Another victory for Pirelli in the WorldMotocross Championship, a traditionspanning more than 20 years

Positive trend of motorcycle originalequipment in 2006 thanks partly to thesuccess of the Metzeler Roadtec Z6



products such as the Diablo Superbike, the Diablo Supercorsa and the Diablo Corsa III under thePirelli brand, and from the Sportec M3, the 6 Days Extreme and the scooter Feel Free under theMetzeler brand.The Pirelli brand was again highly successful in international racing, with its 46th victory in theMX1 category of the World Motocross Championship, the World Sidecar title, first place in thethree main categories of the Italian Speed-racing Championships, victory in the British SupersportChampionship and confirmation of the role of top partner as the Official Tyre Supplier for theWorld Superbike Championship, the Canadian Superbike Championship and the English andAustralian Superstock Championships.For the second consecutive year, the Metzeler brand won a resounding victory in all three of theE1, E2 and E3 categories of the World Enduro Championship, confirming the superiority of theproduct and the professional level of the support service provided for drivers in the competitions.

Industrial market

The Industrial market includes the Truck and Agro Business Unit, the Steelcord Business Unit andsome minor activities associated with them (distribution, reconstruction, etc.).

In the Industrial market, revenues amount to Euros 1,214 million, an increase of 9 percent comparedto the prior year. Overall, the demand was positive in all areas of the market concerning the Truckbusiness (Europe, the Mediterranean and the Middle East, South America and China). In the case ofthe Steelcord business, too, the demand grew everywhere except in North America. The operatingresult from ordinary operations is Euros 104 million, a decrease compared to 2005, owing to thehigh-point reached in the prices of natural rubber, the main cost item on the business’s raw materialsbill, and the fact that it was impossible to transfer the extra cost to the market in such a short time.Because of this, ROS (8.6 percent) was 2.8 points lower than in 2005.In terms of market dynamics, the overall demand was positive in Europe, Turkey and Egypt, while anoverall contraction was reported in South America.

42


The performance of the Diablo sports tyre reconfirms Pirelli in the role as the sole supplier of the World Superbike Championship



In the segment of tyres for Trucks, Pirelli consolidated its share ofthe market in all its reference markets (Europe, the Mediterraneanarea and South America), whereas, in China, where operations wereconducted for the first whole year, attention focused on creating asales network, geographical coverage and the development of thePirelli product. The mix of new products was enhanced with newsizes using SATT® technology (derived from MIRS technology) andby extending this technological platform to Brazil.Racing activities continued, resulting in a number of places on thepodium for the PS22, in races of national and internationalchampionships.

In 2006, the economic performance of Steelcord operationsimproved compared to the prior year despite strong competition onthe market. The growth in volumes was concentrated particularlyon third-party customers and on products with very complexapplications. Growth in world demand is estimated at 7 percent onan annual basis (tons), driven by the continuous growth of theChinese market where consumption is rising by almost 30 percent.Growth is also high in South America and Eastern Europe as aresult of the phenomenon of relocation and greater productioncapacity. The absorption level of the mature markets of NorthAmerica and Western Europe is down. Consumption in Japan andSouth Korea remained constant.Technological evolution means that new, high-resistance cordsmade with special steel and special treatments are continuing tobecome more widespread. The ever-growing investment of thebusiness in cord with high added value is consistent with themaximum commitment that is being placed on know-how. In theindustrial area, growth continues in low-cost areas, where, at theend of 2006, these accounted for more than 66 percent of finishedproduct capacity. During 2006, work continued on the large-scaleexpansion of the production capacity of the plants at Sumarè inBrazil and the plant opened in 2005 at Slatina in Romania.Cord Romania, in collaboration with Continental, not onlyconstitutes an opportunity to develop European productioncapacity at a competitive cost, but also consolidates an industrialand commercial partnership which began in 1972 with DrathcordSaar in Germany.


For the current year, Pirelli Tyre again forecasts a growth in salesabove the market average, thanks to the focus on the premiumsegments in the Consumer area and in the rapidly growing marketsof the Industrial area. In a scenario where the cost of raw materialsstabilizes at current levels, it forecasts a further improvement ofthe operating result in all areas of business.

43


Gigantic Pirelli ST22 tyres at the base ofthe good result achieved by the Tatra teamin the Lisbon-Dakar 2007

Strong expansion of steelcord productioncapacity in 2006 after the Romanian plantat Slatina came on line



Pirelli Broadband SolutionsThe highlights for the year ending December 31, 2006 can be summarized as follows:


Net sales 129.4 112.2Gross operating profit (loss) 1.1 (6.3)% of net sales n.s. n.s.Operating loss (0.3) (7.0)% of net sales n.s. n.s.Earnings (losses) from investments (1.0) -Operating profit (loss) incl. earnings (losses) from investments (1.3) (7.0)Financial income (expenses) (1.6) (0.7)Income taxes (0.4) (0.4)Loss (3.3) (8.1)% of net sales n.s. n.s.Net financial (liquidity)/debt position 13.1 7.2 Employees (number at year-end) 166 122

Net sales

Net sales in 2006 amount to Euros 129.4 million, with an increase of 15.3 percent compared toEuros 112.2 million in 2005. The increase is partly due to the start of activities connected withsecond-generation photonics products with higher-margins (optical components and modules toimprove the performance and flexibility of the telecommunications network) for Euros 14.6 million.

Operating result

The operating result in 2006 is basically a breakeven, compared to an operating loss of Euros 7million in 2005. A positive contribution was made by access activities while photonics was affectedby the investments in research and development typical of the start-up stage and completelyexpensed to income.

Loss

The loss for 2006 is Euros 3.3 million (after financial expenses of Euros 1.6 million). This is animprovement over the prior year and includes the write off of the investment in Alloptic Inc(Euros 1 million).


The net financial position is a net debt position of Euros 13.1 million compared to Euros 7.2 millionat December 31, 2005.

Employees

At December 31, 2006, there are 166 employees, an increase of 44 people compared to December2005, concentrated in the Engineering and Sales functions.

44


IntroductionThe Group2006 operating andfinancialMajor events in 2006Group consolidationPirelli LabsSignificant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocumentsPirelli Tyre

A Pirelli BroadbandSolutionsPirelli & C. Real EstatePirelli & C. AmbienteInformation systemsProforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plansCorporate GovernancePirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

Broadband Access

The broadband market continues to grow, thanks to the release ofADSL2+ technology, which makes it possible to supply users with aband around 20Mb/s.This has made it possible to supply ever-more dynamic surfingprofiles and, furthermore, to provide new service opportunities foroperators, such as television via the Internet (IP-TV) and voice overthe Internet (VOIP).These applications are seen by operators as fundamental steps forwinning the loyalty of their customers and for reaching people whodo not own a computer, who would otherwise not be able tosubscribe to broadband services. In order to confront the marketsituation, a portfolio has been developed consisting of five productlines: access gateways, Set-top Boxes, Extenders, Terminals and thePMP (Pirelli Management Platform).The product range of access gateways extends from simple USBmodems to routers that are capable of supporting triple andquadruple play applications, and even small business and enterprisemachines (thanks to an agreement of strategic cooperation signedwith the French company OneAccess).To augment the competitiveness of the SW solutions used in the access gateways line, technologywas licensed from Jungo, a market leader in the sector, which, in addition to supplying PBS with acomplete stack which is also suitable for small business applications, makes it possible to transfer allthe applications developments implemented by PBS to various xDSL chipsets. This will guarantee alevel of continuity to the services being offered on several platforms, thus augmenting thecompetitiveness of PBS’s proposals to the market.The set-top box line will begin to be supplied early in 2007 with a product that is capable of supportingIP-TV and DVB-T on Linux and Microsoft operating systems. Work has begun to develop a product thatwill support an internal hard disk for use where local registration services are to be provided.

Again with the aim of strengthening its offering of SW, as well as Alcatel OMP and Microsoftmiddleware, it was decided to begin integration of the Confocus stack, which is a fundamentalelement for simplifying various possible commercial middleware solutions or proprietary middlewaresolutions required by the market.With the aim of providing connectivity solutions among the products of the portfolio, the extendersline has been enhanced by a new generation of power line (200Mb/s) and wireless (MIMO) solutions,which make it possible to supply high definition (HD) video streaming between access gateways andset-top boxes, thus helping to solve the problem of installing an IP-TV service.The terminals line has been very successful as a result of dual-mode telephones. In just a few monthsthese have enabled them to acquire new international customers(Arcor, Free and many ISPs) who appreciate the toughness of theproduct and the various configuration possibilities supplied by PirelliBroadband Solutions, as well as the correct price positioning.It was therefore decided to expand the range being offered in 2007,by introducing a product rather like a smart-phone based onWindows Mobile technology, and a “clam-shell” phone which, thanksto the fact that it has a wider screen, will have better browsingcapacity and can support various multimedia features.The PMP has been reorganized to meet developments in the market,supplying a modular system which has proved to be a winningsolution with the acquisition of two new customers (Slovak Telecomand On Telecoms in Greece) towards the end of 2006.

45


Access gateways, set-top-boxes,extenders, terminals and PMPs constitutethe range of Pirelli Broadband Solutions’Broadband Access products

PBS expanded its 2007 dual-modetelephone product line with new smart-phone type products using WindowsMobile technology



In 2007, new functions demanded by the market will be introduced, together with the capacity tomanage the dual-mode telephone.In parallel to telecom-oriented applications, the first “vertical” applications will be launched with the aimof being able to provide services thanks to “bundled” offers between products and operating systems.

New Photonics Products

In 2006, thanks to the continuous penetration of the broadbandservices offering, the phase of strong growth in the communicationsmarket continued, especially in the “metro” area. In this context,Pirelli Broadband Solutions successfully continued to introduce themetropolitan optical transport platform known as City8, selling atotal of more than 1,800 in Italy, France, Germany, Sweden and Spainin less than 18 months after the launch of the product. With regardto this product, a partnership agreement was signed with Ericssonwhich involves marketing City8 and future versions of the producton Ericsson’s worldwide market.In the field of optical components, the qualification of the TunableLaser for application in transmission systems for metropolitan opticaland transport networks was successfully completed and the first supplies of the product began to beshipped in small volumes, destined for customers in North America and the Far East. Samples of theproduct are also in the process of being tested at the premises of many customers in Europe, Japanand North America.Finally, work continues on development of the line of innovative opto-electronic modules (in theMSA-tunable and XFP-pluggable format), begun in December 2005, based on optical devices andnanotechnology (such as the Tunable Laser and the Optical Dispersion Compensator) which weredeveloped in-house. While Europe’s top optical communications event (ECOC 2006) was beingstaged, the new product lines were officially announced, and were enthusiastically received bypotential customers. Main customers continue to test samples of the product.


During the current year, every product line in the access market willbe completed and strengthened to consolidate the marketpositioning of Pirelli Broadband Solutions.This will be achieved both by introducing new technologies such asVDSL2, Wi-Fi 802,11n and AV Power Line, and by enhancing the SWfunctions which will make it possible to supply ever-more integratedend-to-end solutions that can be managed remotely through the PMP.As far as the photonics market is concerned, development work iscontinuing of the City8 platform with the aim of also supporting 10Gbit/s signals and DWDM. The introduction of these functions,which are innovative for such a compact optical product, will resultin a new platform known as LyteWDM which will be able to combinethe versatility and low costs typical of the CWDM systems with thetypical services of a DWDM system of a higher level. In the sphere of components and modules, ashas been described above, the main objective is to complete the product portfolio by introducingtunable and pluggable modules to the market.In 2007, as a result, there is expected to be a further increase in sales, concentrated in the secondhalf of the year, thanks to the completion of the portfolio of solutions for access and the ever-moresignificant contribution of photonics products. Again, in 2007, significant investments will be made inresearch and production to develop new products.

46


PBS – Photonic Products: the City8metropolitan optical transport platformreached sales of 1800 devices in 2006in Europe

The development of the Triplexer opticalchip for Fiber-to-the-Home applicationscontinued successfully during 2006



Pirelli & C. Real EstatePirelli Real Estate is a management company that manages real estate investment funds andcompanies that own real estate and non-performing loans in which it invests by acquiring minoritystakes (Investment & Asset Management). It also provides these and other clients with every kind ofspecialist real estate service (service provider) both directly and through the franchising network.In 16 years of constant growth, Pirelli Real Estate has established a reputation as the leadingoperator in the Italian real estate market, introducing a new business model and professionalstandards from the most highly evolved markets.Today, the Pirelli Real Estate brand is recognized for its tradition, reliability and innovation: the mainfactors behind its success lie in the experience and focusing skills of management and theexperience gained in large-scale operations.

Pirelli Real Estate’s mission can be summarized as follows:• to create value for the shareholders through a system of dealings with the outside community

geared to satisfying all the company’s stakeholders;• to affirm itself as the benchmark of the Italian real estate market; • to export its successful model to Central and Eastern European countries;• to innovate real estate products through a quality response that meets the needs of final users and

investors alike;• to base its corporate governance system on national and international best practices;• to create and disseminate a state-of-the-art culture in the real estate sector;• to orient corporate behavior so that it focuses on the aspects of “corporate social responsibility”.

Pirelli Real Estate is active on the domestic real estate market with offices in Milan, Rome andNaples and, thanks to a qualified network of franchising agencies, the group is able to operateefficiently throughout Italy.

47


Rendering of Pirelli RE’s Headquarter 2 project at Milano Bicocca

IntroductionThe Group2006 operating andfinancialMajor events in 2006Group consolidationPirelli LabsSignificant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocumentsPirelli TyrePirelli BroadbandSolutions

A Pirelli & C. Real EstatePirelli & C. AmbienteInformation systemsProforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plansCorporate GovernancePirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

With regard to the European market, besides Warsaw, the group today has operating offices inHamburg, Berlin and Kiel.The ability to offer itself as the one source for the entire real estate cycle (valuation, purchase,management, appreciation and sale of assets) and the high degree of know-how in various areas ofreal estate operations, have, at the beginning, led the group to attract the most important investmentfunds seeking investment opportunities and, later, also investors interested in core products.The group’s activities are conducted through specific Investment & Asset Management business unitswhich make it possible to effectively and efficiently supervise the various product lines, coordinatingthe work of the service companies and the franchising network for each stage of the process.

Major events in 2006

The Pirelli Real Estate Group conducted a series of importanttransactions in 2006. In particular:

• important purchases of luxury real estate portfolios forapproximately Euros 1,202 million in addition to the purchase ofthe real estate portfolio held by DGAG, Deutsche GrundvermögenA.G., one of the most important real estate companies in Germanyfor approximately Euros 1,400 million. That purchase, concludedin the early days of 2007, together with the one in Poland for thereal estate portfolio of Pekao (UniCredit Group) in 2006,represents a significant step forward in the announced strategy ofexpansion into the countries of Central and Eastern Europe(European markets which hold more interesting growth prospects)where the company has intention of extending the business modelthat has already been successfully adopted for some time in Italy;

• investments in non-performing loans by purchasing new portfoliosfor approximately Euros 977 million, thanks also to new joint ventureswith some of the most important operators of the sector;

• appreciation of the assets under management which made it possible to generate sales to thirdparties of almost Euros 2,806 million with an increase of 14 percent over 2005;

• affirmation of its leadership position in Italy in real estate investment fund management with thelaunch and management of six new products. The operating funds rose from 10 in 2005 to 16 in2006 in addition to another seven funds that have already been authorized. During the period, infact, the following funds started up: Hospitality&Leisure, Armilla, Portafogli Misti, PatrimonioUffici, Progetto Uffici and Progetti Residenza. Specifically, the assets managed by the investmentfunds grew by 25 percent, from Euros 6.1 billion last year to Euros 7.6 billion at December 31,2006;

• finalization of the listing of Spazio Investment N.V. on theAlternative Investment Market of the London Stock Exchange (AIM).This company holds all the shares of the investment in SpazioIndustriale, a real estate investment fund specialized in the lightindustrial/logistics sector launched at the end of the prior year;

• signing, in the services sector, of an agreement to take over IngestFacility from the Fiat Group. Ingest Facility operates the facilitymanagement activities of Fiat in Italy and Europe;

• strengthening of Pirelli Real Estate Franchising’s operations in thedistribution of real estate services to the retail market particularlywith regard to financial products.

48


Rendering of the former ManifatturaTabacchi at Milan, a development projectunder a joint venture between Pirelli REand Fintecna

Pirelli Pekao Real Estate’s Szafarniaproject, at Danzig. Growth prospects forthe real estate sector in Poland are strong



Economic review

In reading the highlights of the income statement presented below, it should be noted that theaggregate revenues and the operating profit including earnings from investments, because of the typeof business conducted by the group, are the most important indicators and express, respectively, theshare of aggregate revenues and the trend in results.


Total aggregate revenues (*) 4,017.8 3,507.2Share of aggregate revenues (**) 1,560.0 1,386.8Consolidated revenues 702.0 700.2Operating profit including earnings from investments (***) 214.4 186.1Income attributable to the equity holders of the company 159.5 145.4(*) Aggregate revenues express total business volumes and include consolidated revenues and revenues of the associates, joint ventures and Funds in which Pirelli

RE has holdings.(**) The share of aggregate revenues expresses the share of business volumes and includes consolidated revenues and the share of the revenues of associates, joint

ventures and Funds in which Pirelli Re has holdings.(***) Operating profiit including earnings from investments comprises the operating profiit (Euros 103.7 million in 2006) in addition to the share of earnings of

companies accounted for by the equity method (Euros 101.6 million in 2006), dividends from holdings (Euros 4 million in 2006) and income from real estateinvestment funds (Euros 5.1 million in 2006).

Aggregate revenues amount to Euros 4,017.8 million, an increase of 15 percent compared to Euros3,507.2 million in 2005.

The share of aggregate revenues amounts to Euros 1,560.0 million, an increase of 12 percentcompared to Euros 1,386.8 million in 2005.

Consolidated revenues amount to Euros 702.0 million compared to Euros 700.2 million in 2005.

Operating profit including earnings from investments is Euros 214.4 million, with an increase of 15percent compared to Euros 186.1 million in 2005. This result recorded a strong growth especially inTertiary Assets, which increased from Euros 100.7 million to Euros 126.0 million, a jump of 25percent, and in the more recent sector of asset management of non-performing loans, which rosefrom Euros 3 million to Euros 11.6 million.

Income attributable to the equity holders of the company is Euros 159.5 million, with an increase ofapproximately 10 percent compared to Euros 145.4 million in 2005.

49




Balance sheet and financial review


Fixed assets 581.7 410.7- including investments in funds and investment companies (*) 426.1 303.3Net working capital 283.3 210.6Net invested capital 865.0 621.3Equity 708.7 552.1- of which attributable to the equity holders of the company 700.3 535.4Provisions 59.9 38.7Net financial (liquidity)/debt position 96.4 30.5- of which shareholder loans (334.1) (262.0)Total net invested capital financed 865.0 621.3Net financial (liquidity)/debt position before shareholder loans 430.5 292.5Gearing ratio (**) 0.61 0.53(*) This item includes investments in associates and joint ventures, investments in real estate investment funds and junior notes.(**) The gearing ratio corresponds to the ratio of the net fiinancial (liquidity)/debt position before shareholder loans to equity.

Equity attributable to the equity holders of the company at December 31, 2006 is Euros 700.3 millioncompared to Euros 535.4 million at December 31, 2005, with an increase of Euros 164.9 million.The change is due to a higher result net of dividends paid during the year (+Euros 82.2 million) andother equity movements (+Euros 82.7 million), largely connected with the decrease in treasury shares.

The net financial position shows a net debt position of Euros 96.4 million compared to Euros 30.5million at December 31, 2005. It includes an advance of Euros 140 million for the DGAG deal.

The adjusted net financial position (expressed before shareholder loans made to minority-ownedcompanies) is a net debt position of Euros 430.5 million, compared to Euros 292.5 million atDecember 31, 2005. The gearing ratio, in line the 2006-2008 three-year plan, is 0.61 compared to 0.53at December 31, 2005.

Fixed assets total Euros 581.7 million compared to Euros 410.7 million at the end of December 2005,with an increase of Euros 171.0 million. The change is due to an increase in the value of theinvestments in associates and joint ventures and investment funds for an amount of Euros 122.8million, in addition to the change in securities mainly from the securitization of the non-performingloans of the former Banco di Sicilia. The remaining amount is largely related to investments for a 75percent stake in Pirelli Pekao Real Estate, for the remaining 12.7 percent interest in Pirelli & C. RealEstate SGR and for the 53.6 percent stake in Credit Servicing.

Net working capital at December 31, 2006 is equal to Euros 283.3 million compared to Euros 210.6million at the end of 2005. The increase of Euros 72.7 million is mainly due to the combined effect ofan increase due to the advance on the purchase of the investment in DGAG (+Euros 140.0 million)and the increase in trade receivables as a result of transactions carried out during the last few daysof 2006 (+Euros 40.6 million), as well as the decrease in net receivables of non-performing loans(-Euros 90.4 million) and inventories (-Euros 8.2 million).


Starting from June and for the entire year 2007, the growth in operating profit including earnings(losses) from investments is expected to exceed the targets set in the 2006-2008 three-year plan(CAGR 10-15 percent).

50




Pirelli & C. AmbienteThe highlights for the year ending December 31, 2006 can be summarized as follows:


Net sales 69.0 61.5 Gross operating profit (loss) 0.5 (2.0)% of net sales n.s. n.s.Operating loss (0.2) (3.6)% of net sales n.s. n.s.Financial income (expenses) (0.1) -Income taxes (0.5) (0.2)Loss (0.8) (3.4)% of net sales n.s. n.s.Net financial (liquidity)/debt position - 0.8Employees (number at year-end) 52 43

Pirelli & C. Ambiente S.p.A.

The result of the company for the year 2006 is a loss of Euros 0.8 million with an improvement overthe loss of Euros 3.4 million reported in 2005.

Net sales amount to Euros 69 million and grew 12.2 percent compared to Euros 61.5 million in 2005.

During the course of 2006, the companies of the Ambiente Group changed names. Pirelli & C.Ambiente Holding S.p.A. took the name of Pirelli & C. Ambiente S.p.A..

Likewise, the three operating companies in the Ambiente Group also changed names:Pirelli & C. Ambiente S.p.A. was changed to Pirelli & C. Ambiente Renewable Energy S.p.A., Pirelli &C. Ambiente Tecnologie Pirelli S.p.A. to Pirelli & C. Ambiente Eco Technology S.p.A. and Pirelli & C.Ambiente Bonifiche S.p.A. to Pirelli & C. Ambiente Site Remediation S.p.A..

The following is a summary of the results of the three operating companies which are wholly-ownedsubsidiaries of the company.

Pirelli & C. Ambiente Renewable Energy S.p.A. (PARE)During the course of the year, the company continued to promote negotiations aimed at starting newprojects in the field of renewable energy using RDF-P (Refuse Derived Fuel-Pirelli) derived fromsolid urban waste for the subsequent development of renewable energy through the replacement ofprimary fossil fuels in existing plants.The result for the year benefited considerably from the agreement which provides for the granting oflicenses, patents, know-how and assistance to the UK and North Ireland start-up by Pirelli & C.Ambiente Renewable Energy S.p.A. to ReEnergy Group Plc.Last January, the company collected the amount agreed for granting the licenses, patents and know-how of Pounds sterling 1.8 million, equal to Euros 2.7 million (Euros 2.9 million net of the 8 percentwithholding tax equal to Euros 0.2 million). This transaction has made it possible to export thebusiness model of the company abroad and to evaluate whether to propose it at an internationallevel.During the year, the activities for producing the quality fuel (RDF-P) were profitably conductedthrough the associate I.D.E.A. Granda S.Cons.R.l. which developed renewable energy of 19,673 tonsof fuel compared to 17,002 tons in 2005.

51


IntroductionThe Group2006 operating andfinancialMajor events in 2006Group consolidationPirelli LabsSignificant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocumentsPirelli TyrePirelli BroadbandSolutionsPirelli & C. Real Estate

A Pirelli & C. AmbienteInformation systemsProforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plansCorporate GovernancePirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

Pirelli & C. Ambiente Eco Technology S.p.A. (PAET)In 2006, the margin generated by the emulsions business largelymade it possible to absorb the start-up costs incurred for the dieselpost-treatment particulate filtering systems and for the OEM filtersproject.With regard to emulsions, there was a decrease of approximately 17percent in volumes of Gecam sold in Italy, compared to the sameperiod of 2005. This was offset by the good performance of per unitmargins and controls over costs and the considerable increase involumes sold in France, which are in line with the strong growthreported also in 2005.With regard to the diesel post-treatment filtering systems, during2006, despite the slowness with which the regulatory framework isevolving at both a regional and national level, work on thedevelopment, fine-tuning and marketing of the systems have beenfurther stepped up.The company has also decided to embark on an investment project in Romania aimed at building aplant for the manufacture of silicon carbide filters for the original equipment market. The newfactory could produce more than 1,300 tons/year of silicon carbide filters with approximately 400employees.

Pirelli & C. Ambiente Site Remediation S.p.A. (PASR)During the year, the company continued its work on the full-scale management of environmentalproblems principally for the companies of the group and related companies, with particular referenceto Environmental Due Diligence, evaluation, planning and management of activities such asdemolition and land reclamation conducted by specialist companies which are authorized to conductsuch work.

52


Pirelli Ambiente Eco Technology: activitiesin the field of post-treatment dieselfiltering systems continued in 2006

In 2006, Pirelli Ambiente Renewable Energy went forward on the development of new projects in the field of RDF-P fuel production

IntroductionThe Group2006 operating andfinancialMajor events in 2006Group consolidationPirelli LabsSignificant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocumentsPirelli TyrePirelli BroadbandSolutionsPirelli & C. Real Estate

A Pirelli & C. AmbienteInformation systemsProforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plansCorporate GovernancePirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

Information systemsThe Information Systems of the Pirelli Group are operated and coordinated through Share ServiceCenter S.c.r.l., a company owned 50 - 50 by Pirelli and Telecom Italia S.p.A..

• Architectures & InfrastructuresWith regard to SAP environments, the Brazilian SAP systems are being moved to the Data Center atCesano Maderno.The Spanish SAP HR systems are being brought into the normal running of all the SAP environmentswithin the Data Center.During the first quarter of 2007, the L20 SAP One Client Latam system will be moved to the DataCenter.The overall SAP environment, currently operated by the Systems Competence Center, now has aproduction Data Base, with approximately 45 Terabytes (approximately 90 Terabytes if theduplication required for the architecture “in mirroring” is considered) of which 9.7 are linked toPrysmian environments, with an average number of 12,000 daily users.In the sphere of the Pirelli Group, work continued to coordinate and integrate the data transmissionnetwork for which work is continuing to increase throughput for the Units included in theinternational backbone. In addition to allowing further consolidation in Milan of services that wereformerly managed locally (Electronic Mail in Spain, Germany and Turkey), this has also made itpossible to extend VoIP services to countries such as Spain, Germany and Turkey.The Latam line is being upgraded to make it more secure for when the One SAP Latam system ismoved to Milan.

With regard to the distributed architecture (APISxp), the migration to the new operating systemWindows R2 for all the WW infrastructure servers was completed, together with the migration of WWelectronic mail systems to Exchange 2003. As services are continuously being centralized, this move,in addition to the network adaptations, has made it possible to bring the electronic mail systems ofGermany, Spain and Turkey to Milan.The architecture is now so widespread that there are more than 16,000 XP customers in more than30 countries. As far as the electronic mail service is concerned, action continued to consolidate theinfrastructure which now comprises only 4 “Exchange sites” WW. The hand-held and smartphoneservice (MIS-PDA-Qtek) now has almost 600 users worldwide.

• Applications ArchitecturesIn 2006, activities focused on reviewing the SAP Roadmap, the support of corporate portals throughthe Intranet and Internet architectures, the issue and distribution of guidelines and developmentstandards, testing and benchmarking new software products and project support.

• Portal and e-business DevelopmentPirelli’s websites continue to show an increase in user traffic,reaching 1,450,000 visitors a month (in December 2005, 1,200,000users visited the website). During the year, the corporate and tyresites were completely restyled, reorganized and innovated, resultingin a complete overhaul of the infrastructure, which had becomeobsolete. In September, the new websites of Pirelli S.p.A., Tyre andBroadband Solutions went online. The website www.pirelli.com wasclassified 5th in the prestigious table drawn up every year byHallvarsson & Halvarsson, which assesses the websites of the 83companies with the highest capitalization listed on the Milan stockexchange and decides which company is the “best improver” of theyear.

53


The www.pirelli.com internet portal wascompletely restyled and reorganized duringthe last part of 2006

IntroductionThe Group2006 operating andfinancialMajor events in 2006Group consolidationPirelli LabsSignificant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocumentsPirelli TyrePirelli BroadbandSolutionsPirelli & C. Real EstatePirelli & C. Ambiente

A Information systemsProforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plansCorporate GovernancePirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

This result was achieved thanks to key services and action in the field of communication, includingthe innovative Pirelli Film project, the broadcasting in high-quality webcasting of financial conferencecalls, the offer of alert services via e-mail and SMS about group events, and the RSS service whichautomatically informs users about the presence of new available content. The release of thePirelli.com website will be followed throughout 2007 by the development of new local websites.During the year, on-going updates continued on the Pirelli Intranet. In this connection, in December,the new Investments Procedure was released for the marketing area, and will be implemented asfrom 2007.

• Pirelli Tyre

Activities focused on aspects of the geographical extension of the One-Client platform, theenhancement and extension of Sell-Side and Supply Chain Value Targeting solutions for the SupplyChain function and PVT (Purchasing Value Targeting) in Purchasing. In addition, work continued onthe functional and geographical extension of the solutions relating to the One-supplier initiative.Particular attention was given to the Product Lifecycle Management project in the sphere of R&D,the up-grade to the new version of the Datawarehouse platform and the review of the rationale andindicators for the Industrial Tableau de Board. There was also a massive update of the product line-up based on the new business rationales for product descriptions and tread codes: with theconsequent modification of SAP and other related applications.

In particular:

• During the year, the One-business/One-client initiative was extended to South Africa, Egypt andJapan and was completed in Romania and China. With regard to the functional extension of theplatform, the following achievements were particularly important: the global review of theprocesses and systems for the management of orders, shipping documents, intercompany invoicesand repeat-invoicing tools taking parameters into consideration; the SAP automation (from orderentry to shipment tracking) of the Singapore branch for the management of the purchase of naturalrubber and the release in Germany and Brazil of MRP (Material Resource Planning) for managinglong-term and execution of materials requirements. The rationalization and consolidation of theSAP One-client Europe and LATAM systems continued with the release, in 2006, of the Cockpit“Virtual One-Client” system for viewing data on a global scale.

• With regard to Sell-Side, and CRM, new contact centers were activated in Austria and Poland, andthe Genesys platform was updated. The Work Flow Management Tool system was released inFrance and Germany while, in Spain, the roll-out of the Mobile Sales Automation system wascompleted. In the area of B2B, integration of the dealer portal with the group’s Datawarehouse wascompleted. The B2Fleet system was released in the U.K. for the Truck Business Unit and in Austriafor the Car Business Unit. Also, new functions were created todematerialize proof of delivery documents and invoices, givingdealers the option of creating and downloading invoices andshipment documents electronically.

• Based on the concept of “extended enterprise”, the SCVT and PVTinitiatives focused on achieving better integration betweencustomers and suppliers. In particular, in the case of SCVT,integration involves: PE customers in Germany, the U.K., the U.S.,Spain and Sweden. With regard to suppliers, integration with theHUB RNC (Rubber Network) led to the integration of suppliers ofraw materials in Germany the U.K., Italy and Spain. One particularlyimportant aspect of the One Supplier initiative is Go-live, the newprocedure for managing pre-invoicing of international road transportin Italy, Germany, the U.K., Spain and European branches.

54


In 2006, new services were added to theMotorcycle Business Unit internet portal



• Important achievements in the sphere of industrial systems includethe completion of the PCS (Production Control System)infrastructure in Romania and activation of Phase 1 (Kanban,WMS, Scheduling and Datacollection) at the new plant at Slatina.Other achievements with regard to PCS, this time in Italy, at theBollate plant, include the activation of Datacollection for theVulcanization area, and, for the Turin Truck and Car plants, theactivation of Datacollection for building phase for the former andthe installation of the CQS (Compound Quality System) module forthe latter. In Germany, PCS was extended for the Motorcycle BU,while, in Spain, the WMS module was activated. SMS(Specification Management System) was implemented at theSteelcord BU in Turkey.

• In the area of R&D, special efforts were made to improve theprotection of corporate know-how, by raising the level of securityof critical applications (adoption of SSL/https protection) andreviewing policies authorizing access to users. Within the sphere of extending the PLM(Product LifeCycle Management) solution, two new elements were added: tools to managethe parameters of information on the sides and the relative CAD designs (Lettering), and toolsto manage the mould specifications, Sector’s Mould Database (MDB). Finally, the roll-out of theRMQ (Raw Material Quality) system was completed in China.

• Pirelli & C. Real Estate

The information systems of Pirelli Real Estate (PRE) were implemented to increase the functionalcoverage and the efficiency of the business systems of the Services Companies, to support thedevelopment of Franchising and SGR, to integrate Credit Servicing in the group and to begin toexpand PRE abroad. There follows a description of the main projects completed in 2006.

• Agency: the new Leasing Valuation application was produced which manages valuationsaccording to ASSILEA standards. The first phase of the development of the new system (Magister)was completed for exploiting business opportunities introduced by the Basel 2 Accord.

• Credit Servicing: the core functions of the new Phoenix management system were released forproduction. The system is being used for newly acquired portfolios, and data about portfoliospreviously managed by another system is gradually being transferred to the new one. New functionswere implemented on the Real Estate Valuation system for acquisitions of new customers.

• Facility: the maintenance system based on SAP-PM has been enhanced by introducing functionsto close maintenance orders via an IVR mobile phone and to calculate and manage SLA onextraordinary maintenance. Customer reporting was developed on a business intelligence platformwhich makes it possible to have dynamic reports. The aim is to standardize and automate theperiodical reports required for operations.

• Franchising: work continues to develop the management systems supporting business lines whichuse the affiliates network as a distribution channel. Financial Products: the integration of UBCasa(UniCredito) and the integration of the system for budget management and commissioning withSAP R/3 were completed. Release 2 of the back office of the Financial Services Center wasreleased. The CRM was integrated with the main commercial partners and the activation processesof affiliated agencies were updated. A system was developed to support the marketing of PREproperty through the network of affiliated agencies (Gessica).

55


The home page of the Investor Relationssection of www.pirelli.com. The portal wasranked fifth in the table drawn up eachyear by Hallvarsson & Halvarsson



• Property: Telematic IRE was released, namely, the possibility of paying the Registration Tax onlease contracts by sending files directly to the website of the Tax Office (Entratel). The “LandRegister” environment for managing ICI and the relative fiscal, legal and asset requirements wascompletely redesigned and released. All the regulations introduced by the Bersani Decree regardingfiscal matters for the management of lease contracts were implemented.

• Foreign business: activities to integrate the Warsaw office in the standards of the Pirelli networkwere completed. The first SAP implementation phase for Poland was concluded (modules FI, COand SD) and implementation was completed of the new model of the “Foreign Development”Business Plan being used by Polish asset managers. The Due Diligence on the information systemsof DGAG, the company acquired in October, was completed.

• PRE Management Control: the new Tableau de Board of the Purchasing function was released andthe Tableaux de Board of Project and Franchising were revised to bring them into line with thenew business models. Development of the new Tableau for PRE’s Integrated Income Statement wascompleted and the new Tale for the new Agency, Franchising and Property management plan werereleased. The new MIS model for group consolidation was redesigned.

• SGR: the new Armilla fund was opened and management of it began.

• SGR Opportunities: the Information System was implemented and the first five funds were created.

• For all the companies of the PRE Group: the new corporate website (www.pirellire.com) wasreleased and the new method of sending invoices to customers through the Postel platform wasimplemented.

• Pirelli Broadband Solutions

In the Systems business, development activities concentrated on the area of purchasing and logistics.In particular, the following functions were released:• Activation of a SAP workflow of the approval process of an ECR (Engineering Change Request);• Additional functions in the process of Vendor rating and reporting for assessing suppliers;• Management flow of the new type of MAS products;• Electronic saving of purchasing documents in PDF;• Additional functions in the corporate Intranet including a dedicated area for top management and

workflow in the document approval cycle;• Activation of SAP Profitability Analysis (COPA);• Activation of interfaces between SAP and the CAD system (Mentor);• Opening of the new company Pirelli Broadband Solutions North America.

Furthermore, in June, the new webpage www.pirellibroadband.com was released.

56




Proforma data

Proforma consolidated economic and financial data assuming the line-by-line consolidationof Olimpia S.p.A.

Proforma consolidated data at December 31, 2006 of Pirelli & C. S.p.A. is presented below, assumingthe consolidation line-by-line of Olimpia S.p.A..

Proforma adjustmentsConsolidated Elimination of Olimpia Olimpia Total Proforma

financial Olimpia S.p.A. S.p.A. consolid. proforma consolidatedstatements result line-by-line entries adjustments financial 12/31/2006 attributable consolid. statementsPirelli & C. to Pirelli & C. 12/31/2006

(in millions of euros) S.p.A. (1) S.p.A. Pirelli & C.IAS/IFRS S.p.A. (2)

Condensed income statementNet sales 4,841 - - - - 4,841 Operating profit 401 - (1) - (1) 400 Financial income (expenses)/valuation adjustments to financial assets (1,292) 1,940 (2,715) - (775) (2,067) Income taxes (128) - - - - (128)Income (loss) from continuing operations (1,019) 1,940 (2,716) - (776) (1,795)Income (loss) from discontinued operations (30) - - - - (30)Total Income (loss) (1,049) 1,940 (2,716) - (776) (1,825)Income (loss) attributable to the equityholders of Pirelli & C. S.p.A. (1,167) 1,940 (1,940) - - (1,167)Reclassified balance sheetEquity 4,687 1,940 4,360 (5,428) 872 5,559- of which equity attributable to the equity

holders of Pirelli & C. S.p.A. 3,880 1,940 3,488 (5,428) - 3,880Net financial (liquidity)/debt position 1,980 - 3,216 - 3,216 5,196(1) Pirelli & C. S.p.A. consolidated financial statements (investment in Olimpia S.p.A. accounted for by the equity method with Olimpia accounting for Telecom Italiaby the equity method). (2) Proforma Olimpia financial statements used for line-by-line consolidation of Olimpia S.p.A..

The proforma consolidated economic and financial data has been prepared using:

• the financial statements of Olimpia S.p.A. at December 31, 2006, adjusted to conform with IFRS,wherein the investment in Telecom Italia S.p.A. is accounted for by the equity method (usingfinancial statements prepared in accordance with IFRS);

• the consolidated financial statements of Pirelli & C. S.p.A. at December 31, 2006 (prepared inaccordance with IFRS) wherein Olimpia S.p.A. is accounted for, in turn, by the equity method.

The principal proforma adjustments included in the above table are as follows:

• in the column “Elimination of Olimpia S.p.A. result attributable to Pirelli & C. S.p.A.”: elimination ofthe income statement and balance sheet effects of valuing Olimpia S.p.A. by the equity method inthe Pirelli & C. S.p.A. consolidated financial statements at December 31, 2006;

• in the column “Olimpia S.p.A. line-by-line consolidation”: inclusion of the assets, liabilities, costsand revenues resulting from the financial statements at December 31, 2006 of Olimpia S.p.A.,prepared in accordance with IFRS consistent with the Pirelli Group, attributing the share of netequity and the results of operations to the minority interest. It should be pointed out that theforward purchase of 124,129,937 Telecom Italia S.p.A. ordinary shares, concluded by Olimpia S.p.A.in 2001, was accounted for at original cost as an increase in the investment in Telecom Italia S.p.A.with a contra-entry to the relative payable account;

57


IntroductionThe Group2006 operating andfinancialMajor events in 2006Group consolidationPirelli LabsSignificant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocumentsPirelli TyrePirelli BroadbandSolutionsPirelli & C. Real EstatePirelli & C. AmbienteInformation systems

A Proforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plansCorporate GovernancePirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

• in the column “Olimpia S.p.A. consolidation entries”, the carrying amount of the Olimpiainvestment in the Pirelli financial statements was eliminated against the underlying share of theaccounting net equity.

A comparison of equity and net debt between the consolidated financial statements of Pirelli & C.S.p.A. and the proforma consolidated financial data of Pirelli & C. S.p.A. at December 31, 2005 and atDecember 31, 2006 is presented below, assuming:

• the line-by-line consolidation of Olimpia S.p.A.;

• the line-by-line consolidation of both Olimpia S.p.A. and the Telecom Group.

(in millions of euros) Equity Net debt Net debt/ Equity attributable to the IAS/IFRS Equity equity holders of

Pirelli & C. S.p.A.12/31/2006 12/31/2005 12/31/2006 12/31/2005 12/31/2006 12/31/2005 12/31/2006 12/31/2005

Pirelli & C. S.p.A. Group:consolidated data 4,687 5,614 1,980 1,177 0.42 0.21 3,880 5,205Pirelli & C. S.p.A. Group:proforma consolidated data with Olimpia S.p.A.consolidated line-by-line 5,559 8,393 5,196 4,667 0.93 0.56 3,880 5,205Pirelli & C. S.p.A. Group:proforma consolidated data with Olimpia S.p.A.and the Telecom Italia groupconsolidated line-by-line 29,263 32,029 42,497 44,525 1.45 1.39 3,880 5,205

58


IntroductionThe Group2006 operating andfinancialMajor events in 2006Group consolidationPirelli LabsSignificant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocumentsPirelli TyrePirelli BroadbandSolutionsPirelli & C. Real EstatePirelli & C. AmbienteInformation systems

A Proforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plansCorporate GovernancePirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

59


Equity Investments held by Directors, StatutoryAuditors and General ManagersPursuant to article 79 of Consob Regulation approved by resolution No. 11971 dated May 14, 1999,the following information is provided as regards the equity investments held in the company Pirelli &C. S.p.A., and its subsidiaries, by the Directors, Statutory Auditors and General Managers, as well asspouses, not legally separated, and minor children, either directly or through subsidiaries, trusteecompanies or individual persons, resulting from the shareholders’ register at December 31, 2005,from notices received or other information acquired from the same Directors, Statutory Auditors andGeneral Managers.

Name Company in which No. of shares No. of shares No. of shares No. of shares investment held held at prior purchased / sold held at

year-end subscribed current year-end

Tronchetti Provera Marco Pirelli & C. S.p.A. 13,764 13,764Pirelli & C. S.p.A.(indirect ownership) 1,323,599,275 (1) 1,323,599,275 (1)

Pirelli & C. S.p.A.(indirect ownership) 1,217,398 (2) 1,217,398 (2)

Pirelli & C. Ambiente S.p.A. (indirect ownership) 10,478,000 (1) 10,478,000 (1)

Pirelli Alberto Pirelli & C. S.p.A. 29,925 29,925 Puri Negri Carlo Alessandro Pirelli & C. S.p.A. 66,500 66,500

Pirelli & C. Real Estate S.p.A. 449,500 555,000 1,004,500 Buora Carlo (4) Pirelli & C. S.p.A. 68,688 68,688 Ligresti Giulia Maria (3) Pirelli & C. Real Estate S.p.A. 10 10 Moratti Massimo Pirelli & C. S.p.A. 11,551,427 11,551,427

Pirelli & C. S.p.A.(indirect ownership) 37,427,732 (5) 37,427,732 (5)

Pirelli & C. S.p.A.(indirect ownership) 11,328,318 6) 11,328,318 (6)

De Conto Claudio Pirelli & C. S.p.A. 55,258 55,258 Gobbi Luciano Pirelli & C. S.p.A. 150,000 150,000 Guatri Luigi Pirelli & C. S.p.A. 186,654 (3) 186,654 (1) Shares held through Camfin S.p.A.(2) Shares held through Cam Partecipazioni S.r.l.(3) Shares held through spouse(4) In office until November 6, 2006(5) Shares held through CMC(6) Shares in the name of Istifid as a trustee

Stock option plansThe information on stock option plans previously provided in accordance with Consobcommunication No. 11508 dated February 15, 2000 has now been included in the notes to theconsolidated financial statements.

IntroductionThe Group2006 operating andfinancialMajor events in 2006Group consolidationPirelli LabsSignificant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocumentsPirelli TyrePirelli BroadbandSolutionsPirelli & C. Real EstatePirelli & C. AmbienteInformation systemsProforma data

A Equity Investments heldby Directors, StatutoryAuditors and GeneralManagers

A Stock option plansCorporate GovernancePirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

Corporate GovernanceIntroduction

The Company is aware of the importance of its Corporate Governance system in fulfilling its objectiveof creating value for all shareholders and making progress in sustainable development, and thus inducesthe Company to keep its own corporate governance system constantly in line with national and interna-tional best practices, as well as making sure that it is up to date with legislative changes.

During 2006, the Company – after having implemented changes according to the national legislation andregulations regarding market abuses – launched an overall survey and updating of its corporate gover-nance instruments, in order to align them with provisions under the law no. 262/2005 and the legislativedecree No. 303/2006 (henceforth, respectively, the “Savings Law” and the “Corrective Decree”), aswell as recommendations in the new edition of the Self-Regulatory Code for listed companies publishedin March 2006 (henceforth the “new Code of Conduct”).

With reference to updates made according to the new Code of Conduct, we note that the Company –having formalized its adherence to this code at the Board of Directors meeting on March 12th, 2007 –avails itself of the faculty, conceded by the Borsa Italiana, to make reference in this Report to the Self-Regulatory Code published in July 2002 (henceforth the “Code”), indicating the completed or plannedactivities made in order to adhere to the recommendations indicated in the new Code of Conduct.

As a preview to the points elaborated in detail in this report, we note that the complete review of thegovernance framework – which was carried out by a specific working team coordinated by theSecretary to the Board of Directors and subject to constant attention (in three consecutive meetingsduring which the Board of Statutory Auditors participated as well) by the Committee for InternalControl and Corporate Governance, which formulated the proposals to the Board of Directors – broughtabout the defining of a series of changes that did not significantly modify the company governance,which proved to be largely in line, if not to the letter at least in substance, with the new relevant regu-latory framework.

The governance system adopted by the Company, before and after the revision mentioned above, is andremains founded on the central position of the Board of Directors, on the presence of correct disclo-sure practices regarding the choices and the procedures for the decisions of the Company, on an effec-tive system of internal controls, on an effective monitoring for potential clash of interests and on a rig-orous code of conduct regarding the implementation of transactions with related parties.

These benchmarks are specified in the Code of Ethics, in the Company bylaws, in the Regulationsregarding shareholders’ meetings, and in a series of principles, rules and procedures that are availableon the website of the Company at www.pirelli.com under the section dedicated to the Governance.

In compliance with the regulation of markets instructions organized and managed by Borsa Italiana andtaking also into account information included in the “Guidelines for the drawing up of the annual reporton corporate governance” published by Borsa Italiana and in the “Corporate governance reports hand-book” published by Assonime, this report describes the main characteristics of the corporate gover-nance system of the Company and the functioning of its various components during the 2006 financialyear, as well as it accounts for its already existing activities and those planned for the future in order toensure compliance with the new Code of Conduct, in accordance with Borsa Italiana indications madeon November 16th, 2006.

60


IntroductionThe Group2006 operating andfinancialMajor events in 2006Group consolidationPirelli LabsSignificant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocumentsPirelli TyrePirelli BroadbandSolutionsPirelli & C. Real EstatePirelli & C. AmbienteInformation systemsProforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plans

A Corporate GovernancePirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

GOVERNANCE STRUCTURE

1. Company Organisation

The Board of Directors In line with Italian regulations, the management of the Company is entrusted to a Board of Directorsthat plays an active role regarding its strategic directions, as well as its management control, whiledirecting administration as a whole and having a direct hand in a series of decisions that are neces-sary or useful in the pursuit of the corporate aims. In order to fulfil its tasks, the Board avails itself of the assistance of Committees established with-in it (i.e. the Remuneration Committee and the Committee for Internal Control and CorporateGovernance), entirely composed of independent directors.

The Board of Statutory Auditors According to the law and the Company bylaws, the Board of Statutory Auditors is entrusted withthe following: - the observance of the law and the bylaws; - the respecting of proper administration principles;- the adequacy of the organisational structure of the Company for the aspects within its compe-

tence, of the internal control and administration-accounting systems, as well as the latter’s relia-bility in correctly representing management results;

- the methods of application of the corporate governance rules contained in the codes of conductprepared by companies that manage regulated markets or associations of category, which thecompany declares to follow;

- the adequacy of the regulations imposed by the Company on its subsidiaries regarding the report-ing of price sensitive information1.

The Board of Statutory Auditors fulfils its tasks by exercising all of the powers conferred upon it bylaw and being able to count on a constant and analytical information flow from the Company, dur-ing and beyond the regular meetings of the Board of Directors and its Committees. In fulfilling its functions, the Board of Statutory Auditors, besides participating in all the Board ofDirectors and Shareholders’ Meetings, also takes part in the tasks of the Remuneration Committeeand the Committee for Internal Control and Corporate Governance. Moreover, Paolo FrancescoLazzati, a Statutory Auditor, is a member of the Monitoring Board in accordance with the legislativedecree No. 231/2001.

The Shareholders’ MeetingThe Shareholders’ meeting – that may be ordinary or extraordinary – has the competence, accord-ing to the law, for resolving upon a series of specified matters such as the approval of the financialstatements, the election and the revocation of directors and statutory auditors, their fees andresponsibilities, the purchase or sale of own shares, the modification of the Company bylaws, theissuance of convertible bonds, and, except for restricted cases, merger and division transactions.The Shareholders’ meeting, which may be held in Italy also out of the registered office of theCompany, must be called within 120 days, or in special circumstances within 180 days, as from theend of the financial year; if the meeting is called within 180 days, the directors must indicate the rea-son for the delay in the Directors’ Report included in the year-end financial statements.In addition to the law and the bylaws, shareholders’ meetings are governed by the Rules ofProceeding, which were approved by the shareholders’ meeting held on May 11th, 2004 (availableon the website of the Company www.pirelli.com in the section entitled “Governance”). In order topay attention to the possible integration of the agenda on shareholders’ request, as introduced by

61




1 Now known as “sensitive information” (art. 114 of the Legislative Decree No. 58/1998).

the Savings Law, the Board of Directors, in the meeting held on March 12th, 2007, resolved to pro-pose to the shareholders – at the meeting called to examine the 2006 financial statements – somemodifications to the Rules. For full details of these proposals, please see the report that was draft-ed by the Directors regarding this matter. The Shareholders’ Meeting is chaired, in the following order, by the Chairman of the Board ofDirectors, by a Deputy Chairman or a Managing Director; if there are two or more Deputy Chairmenor Managing Directors, they are chaired by the senior in age. In the absence of the aforementionedindividuals, the Shareholders’ Meeting is chaired by another person elected by the shareholderswith the favourable vote of the majority of the capital represented at the meeting.The Chairman of the shareholders’ meeting – among other things – verifies that the meeting hasbeen validly constituted, ascertains the identity of those present and their right to attend, includingby way of proxies, ascertains the legal quorum and governs the proceedings, with the facultyto establish a different order for the discussion of the topics listed in the agenda indicated in thenotice convening the meeting. The Chairman also takes appropriate action to ensure orderly discus-sion and voting, establishing the procedures and verifying the results. The decisions of the meetingare recorded in minutes signed by the Chairman of the meeting and the Secretary or by the Notarypublic.The minutes of extraordinary Shareholders’ Meetings must be prepared by a Notary public appoint-ed by the Chairman of the meeting.

Audit of accountsThe audit of accounts activity is carried out by an auditing firm appointed during a Shareholders’Meeting and chosen among those listed in a specific register held by Consob.The task – conferred in reference to the 2005-2007 financial years at the Shareholders’ Meeting heldon April 28th, 2005 – is currently entrusted to PricewaterhouseCoopers S.p.A., which was alsoappointed by other major Group companies to audit their accounts.

2. Composition of share capital

On March 12th, 2007 the share capital of Pirelli & C. S.p.A. was ¤2,791,311,344.64, divided into no.5,367,906,432 shares with a par value of ¤0.52 each, of which no. 5,233,142,003 were ordinaryshares and no. 134,764,429 were non-convertible savings shares.The share capital may further increase up to a nominal maximum of ¤2,819,508,786.64 by meansof the issue of a maximum of no. 54,225,850 ordinary shares ¤0.52 each, at a price of ¤1.15 each,of which ¤0.63 as a share premium, against the possible exercising of options granted to managersand cadres employed by the Company, by its subsidiaries and by the subsidiaries of the latter aspart of the “Pirelli to People” and “Group Senior Executives” stock-option plans set up by PirelliS.p.A. in 2001.To the best of the Company’s knowledge, no legal or natural person can exercise controlaccording to the Article 93 of the Legislative Decree 58/1998 (henceforth the “Financial ServicesAct”). Participants in the Pirelli & C. S.p.A. Block Share Syndicate, the purpose of which is to ensurePirelli & C. share structure stability, and an excerpt of the relevant agreement are listed at thebottom of this chapter and are available on the website of the Company at www.pirelli.com.

62




Implementation of provisions in the self-regulatory code

1. Board of Directors

1.1 Role and functionsAs mentioned, the Board of Directors plays a central role in the Company’s corporate governancesystem; it has the power (and the duty) to direct Company business, pursuing and fulfilling itsprimary and ultimate objective of creating shareholder value. Pursuant to Article 11 of the Company bylaws, the Board is responsible for the management ofthe Company and, to this end, it is vested with the broadest powers, except for those mattersremitted by law or the bylaws to the authority of the shareholders’ meeting.In line with the provisions in the Self-Regulatory Code for listed companies (new editionpublished March 2006), the Board of Directors has the exclusive right to: - examine and approve the strategic, business and financial plans of the Company and the Group;- draw up and adopt the corporate governance regulations of the Company and define the gover-

nance guidelines of the Group;- evaluate the adequacy of the general organisational, administrative and accounting structure of

the Company as well as of those subsidiaries of strategic importance as set up by the ManagingDirectors, with special reference to internal auditing and the management of clashes of interests;

- grant powers to the Managing Directors and the Executive Committee (if established) and revokethem; fix the limits, the manner in which they have to be exercised and the frequency, at least ona quarterly basis, with which such bodies must report to the Board on the activity performed inthe exercise of the powers granted;

- determine, after having examined the Remuneration Committee proposals and consulted theBoard of Statutory Auditors, the remuneration of the Managing Directors and of those directorswho are vested with special offices and, if the shareholder meeting has not already resolved uponit, allocate the total amount to which the members of the Board of Directors are entitled;

- evaluate the general performance of the Company, taking particularly into consideration theinformation received from the entrusted corporate bodies and compare periodically the resultsachieved with those planned;

- examine and approve all transactions involving the Company and its subsidiaries which have asignificant impact on the strategy, the profitability, the assets or the financial position of theCompany, paying particular attention to situations in which one or more directors act in their owninterest or in the interest of third parties, and more generally to transactions with related parties.During the revision of the corporate governance instruments, it was expressly stated that theBoard of Directors establish general criteria for the detection of these kinds of transactions;

- at least once a year, evaluate the size, composition and functioning of the Board itself and itsCommittees, expressing in case an opinion on the professional figures whose presence in theBoard could be deemed advisable;

- establish the Self-Regulatory Body, pursuant to Legislative Decree 231 of June 8th, 2001;- appoint and dismiss the position of the responsible for internal control, determine relevant duties

and fees, taking into consideration the advices of the Committee for Internal Control, theCorporate Governance Committee and the Board of Statutory Auditors;

- assess and approve periodic reports prepared according to applicable legislation; - exercise other powers and fulfil duties as required by the law and the Company bylaws.

1.2 Appointment of DirectorsSince 2004, the Company bylaws have stated (in article 10) that the appointment of the Board ofDirectors shall take place through a slate vote and therefore they are already in line with the regu-

63




lations introduced by the Savings Law in the Financial Services Act. This system ensures that – ifmore than one slate is presented – minority shareholders can elect one fifth of the Directors.The slates presented by shareholders, undersigned by the parties submitting them, must be deposit-ed at the registered office of the Company at least ten days prior to the date set for the sharehold-ers’ meeting to be held on first call and made available to anyone on request.Each shareholder may present or participate in the presentation of only one slate and each candi-date may appear on only one slate, on pain of ineligibility.Only shareholders who, alone or together with other shareholders, hold at least 2 per cent of theshare capital entitled to vote at the ordinary shareholders’ meeting, may present slates, subject totheir proving ownership of the necessary number of shares not later than two days prior to the dateset for the shareholders’ meeting to be held on first call.Declarations in which the candidates individually accept their candidacy and attest, on their ownresponsibility, that there are no grounds for ineligibility or incompatibility, and that they meet therequirements prescribed by law and the bylaws, must be deposited together with the slates withinthe time limit specified above. The declarations must be accompanied by a curriculum vitae foreach candidate regarding his personal and professional characteristics, with the possible indicationthat the candidate qualifies as independent.As per international best practices, the renewal of the administrative body of the Company allowsshareholders to vote individually on: (i) the number of people on the Board of Directors; (ii) theelection of Directors through a vote on the presented slates; (iii) the duration of the mandate of theBoard of Directors; and (iv) the pay packages of the Directors.In reference to the election methods, it seems pertinent to note that the Board of Directors that con-vened on March 12th, 2007 – in order to align the above-mentioned elections system with the newprovisions introduced by the Savings Law and the Corrective Decree, as well as recommendationsin the new Code of Conduct – proposed some changes at the following Shareholders’ Meeting aim-ing at (i) allowing for the percentage of share capital required to present slates to be less than 2% ifso deemed by Consob (ii) increasing the time within which slates must be presented to 15 days, and(iii) together with the depositing of the curriculum vitae of each candidate, requiring a list of all theadministrative and control positions that the candidate has held in other companies, and requiringthat the candidate be suitable to be qualified as an independent Director according to legal andCompany criteria.During the same meeting, following a specific recommendation in the new Code of Conduct (crite-rion no. 1.C.3.), which requires the Board to express an opinion regarding the limit of the numberof director’s or auditor’s positions held in other companies that can be considered compatible withadministrative positions in Pirelli & C., the Board mandated the Committee for Internal Control andCorporate Governance to draw up a proposal regarding this point.

1.3 The composition of the Board of DirectorsThe Board of Directors of the Company, as established by the bylaws, consists of no less than sevenand no more than twenty-three members.The Board of Directors in office on April 28th, 2005 was renewed for three financial years (and willtherefore be the Board that will convene for the approval of the financial statements at December31st, 2007), and set the number of its members at twenty. Through a vote, the minority list therefore nominated four Directors, i.e. one fifth of the total num-ber. Two lists were presented, one by the participants in the Pirelli & C. S.p.A. Share BlockSyndicate and the other by various savings management companies. Those proposing the slatesmade the candidates’ profiles available so that the candidates’ personal and professional character-istics, as well as some candidates’ qualifications as independents, were made known prior to vot-

64




65




ing. The curricula vitae presented when the slates were filed were promptly published on theCompany web site at www.pirelli.com, where they remain available in an updated version.During 2006, some changes were made in the system of directors. Specifically, following the resig-nation of the Director Carlo De Benedetti – which took place in May – the Board of Directors con-vened on September 12th, 2006 nominated Alberto Bombassei who, in accordance with legislation,will remain in office until the next Shareholder Meeting. Subsequently, on November 6th, 2006 CarloBuora resigned from his post of Managing Director and Board Member (as well as GeneralManager) of the Company. Not having added any more members, the Board of Directors is therefore currently comprised ofthe following 19 members:

Marco Tronchetti Provera ChairmanAlberto Pirelli Deputy ChairmanCarlo Alessandro Puri Negri Deputy ChairmanCarlo AcutisCarlo Angelici Member of the Committee for Internal Control and

Corporate Governance Gilberto BenettonAlberto BombasseiFranco Bruni Member of the Committee for Internal Control and

Corporate GovernanceGabriele Galateri di GenolaMario GarraffoDino Piero GiardaBerardino Libonati Chairman of the Remuneration CommitteeGiulia Maria LigrestiMassimo MorattiGiovanni PerissinottoGiampiero Pesenti Member of the Remuneration CommitteeAldo Roveri Member of the Remuneration CommitteeCarlo Secchi Chairman of the Committee for Internal Control and

Corporate Governance and Lead Independent DirectorPaolo Vagnone

Carlo Angelici, Franco Bruni, Mario Garraffo and Aldo Roveri were minority candidates. Three of the members of the Board of Directors are executive directors as defined in Article 2.C.1of the new Code of Conduct: The Chairman Marco Tronchetti Provera, and (due to the executiveduties bestowed upon them regarding the companies Pirelli Tyre S.p.A. and Pirelli & C. Real EstateS.p.A.) Deputy Chairmen Alberto Pirelli and Carlo Alessandro Puri Negri. The Board of Directors evaluated the role of independent directors based on the most rigorousrequirements in the new Code of Conduct (criterion 3.C.1.) which states that an independent direc-tor may not be – by law – considered independent: a) if they, directly or indirectly or on behalf of subsidiaries, trust companies or through third par-

ties, control the issuer or are able to exercise considerable influence, or are a participant in ashareholder agreement through which one or more individuals can exercise control or significantinfluence on the issuer;

2 The following are considered “members of prominence” of a company or body: the chairman of the body, the legal representa-tive, the chairman of the board of directors, the executive directors and managers with strategic responsibilities within the com-pany or body concerned.

66




b) if they have or have been in the past three financial years a member of prominence2 of the issuer,or one of its strategic subsidiaries or a company under joint control with the issuer, or a compa-ny or a body that, alone or together with others in accordance with shareholders agreements,control the issuer or are able to exercise considerable influence;

c) if directly or indirectly (e.g. through subsidiaries or bodies that have a significant position, suchas a partner of a law firm or a consultancy company) they have, or had in the previous financialyear, a close business, financial or professional relationship with the following:– the issuer, one of its subsidiaries, or any related prominent exponent thereof; – an individual who, alone or together with others within a shareholder agreement, controls the

issuer, or – if a company or body – with related prominent exponents thereof;or if, in the previous three financial years, they were an employee of one of the above-mentionedindividuals or bodies;

d) if they receive, or in the past three financial years received, from the issuer or one of its sub-sidiaries or parent companies, a substantial bonus compared to their “fixed” salary as non-exec-utive director of the issuer, including performance-based incentive plans, such as stock bonusesor other;

e) if they have been a director for more than nine years of the past twelve; f) if they are an executive director in another company in which the executive director of the issuer

holds the role of director;g) if they are a board member or director of a company or body belonging to the company mandat-

ed to audit the accounts of the issuer;h) if they are a close family member of a person that finds themselves in one of the situations

described above.Following a lengthy evaluation of the information supplied by the Directors and available to theCompany, the Board of Directors – also based on declarations made by the same – judged 10 of theremaining 16 directors (Carlo Acutis, Carlo Angelici, Alberto Bombassei, Franco Bruni, MarioGarraffo, Dino Piero Giarda, Berardino Libonati, Giampiero Pesenti, Aldo Roveri and Carlo Secchi)may be qualified as independent directors, while the other six (Gilberto Benetton, Gabriele Galateridi Genola, Giulia Maria Ligresti, Massimo Moratti, Giovanni Perissinotto and Paolo Vagnone) maybe qualified as non-executive directors.

Moreover, we note that the Board of Directors has checked that all directors qualified as independ-ent may also be so deemed in accordance with the requirements for members of the board of statu-tory auditors in the Financial Services Act, as amended by the Savings Law. A table at the end of this chapter shows the positions which the directors of the Company hold asdirector or member of the board of statutory auditors in other listed companies in Italy and abroad,in financial, banking and insurance companies, and in other large companies.

1.4 The role of Lead Independent DirectorAs of November 2005, in order to increase further the role of the ten Independent Directors, theBoard of Directors decided to introduce a Lead Independent Director. The Lead IndependentDirector (Carlo Secchi, the Chairman of the Committee for Internal Control and CorporateGovernance, was chosen) coordinates and acts as a point of reference for the requirements andcontributions of the independent Directors. The Lead Independent Director may also convene – on his own initiative or upon the request ofother Directors – specific meetings solely for independent Directors (i.e. Independent Directors’executive sessions) in order to discuss subjects occasionally felt to be of interest to the functioningof the Board of Directors or management of the firm.

67




Please note that the Lead Independent Director may collaborate with the Chairman of the Board ofDirectors for the better functioning of the Board of Directors. During 2006, two Independent Directors’ executive sessions were held that involved the discussionof intrinsic subjects to the corporate governance of the Company, the role and function of the inde-pendent Directors and the accounting measurement of the shareholding held in Olimpia S.p.A..During 2007, one Independent Directors’ executive session has already been held.

1.5 Board performance evaluationDuring 2006, for the first time, the Board of Directors made a self-evaluation of its performance (offi-cially called a “Board performance evaluation”), thus adhering to international best practices and theprovisions in the new Code of Conduct (criterion 1.C.1., letter g); this evaluation studied the size, thecomposition and the functioning of the Board and its Committees, and was carried out with the assis-tance of a specialised external consultancy company that worked side by side with the Committeefor Internal Control and Corporate Governance in order to set self-evaluation methods and analysethe results.A generally positive evaluation of the Board and its work emerged from an analysis of the results,together with useful suggestions to improve its functioning further.

1.6 Board of Directors MeetingsDuring 2006, 10 Board of Directors meetings were held. The overall participation level of Directorswas about 77%; the independent Directors ensured that their average overall attendance level washigher than 80%.The bylaws do not provide for a minimum frequency of Board of Directors meetings. It is, howev-er, the practice for the Board to convene on June 30th to examine the preliminary data, the budgetproject and the quarterly and biannual reports. As a rule, at the end of the last Board meeting ofeach financial period, the market is informed of the timing of the major company events (that is,Board and Shareholders’ Meetings) planned for the following financial period. Any changes arepromptly communicated to the market.In November 2006, the Company distributed a schedule for five meetings in 2007. The schedule con-firms the advance publication, also in 2007, of the budget documentation and the biannual report(making it possible, among other things, to take advantage of the exemption from the drawing upof the fourth 2006 quarterly report and of the second 2007 quarterly report). The Board meetings may take place by means of telecommunication enabling participation of allparties concerned, with equal information, in the debate.The Board of Directors meetings are convened by means of letter, telegram, fax or e-mail sent atleast five days prior (or, in the event of emergencies, at least six hours prior) to the meetings. EachDirector and Acting Auditor is called to the meetings.Barring exceptional cases, the Directors and the Auditors have always received early enough thenecessary documentation and data in order to express an informed opinion on the materials sub-ject to their examination.

1.7 Directors’ remunerationIn addition to reimbursement for expenses incurred in performing their duties, Directors receiveannual fees determined by the shareholders’ meeting (Article 14 of the bylaws).The meeting of April 28th, 2005 decided “to establish a maximum of ¤1,200,000 as the total annualcompensation to the Board of Directors pursuant to Art. 2389, paragraph 1, of the Civil Code, anamount to be distributed among its members in conformity with decisions taken in this regard bythe Board.” At the same meeting, on April 28th, 2005, the Board of Directors established the distribution of thecompensation as follows:- € 50,000 annually for each of the 20 members of the Board of Directors;

3 With the exception of Deputy Chairman Carlo Alessandro Puri Negri, in that, as Chief Executive Officer of Pirelli & C. Real EstateS.p.A., he holds stock options in that company.

68




- € 25,000 annually for each of the members of the Committee for Internal Control and CorporateGovernance;

- € 20,000 annually for each member of the Remuneration Committee, with the right being reservedto use the residual amount (¤65,000) in the future to give the Board a margin of organizationalflexibility, including for the adoption of any new governance solutions.

A payment of ¤10,000 annually is also made to the Board member taking part in the Self-RegulatoryBody as per legislative decree no. 231/2001 (Carlo Secchi).The Board of Directors upon consultation with the Board of Statutory Auditors establishes remu-neration for directors given particular tasks, as proposed by the Remuneration Committee. The cur-rent remuneration system provides for payments to comprise a fixed amount and an additionalbonus linked to the performance of the Group, and to be related to the attainment of specific objec-tives set by the Board. Information on the remuneration of the directors entrusted with special powers can be found in achart in the notes to the financial statements for 2006.Lastly, it should be noted that there are no stock-option plans for either the executive or the non-executive directors3.

1.8 Delegated powers Taking into consideration and according to the new corporate regulations established in legislativedecree no. 6/2003, the Chairman Marco Tronchetti Provera and the Managing Director Carlo Buora(the latter of which ended his mandate on November 6th, 2006) were identically recognized as legalproxies of the Company, each given legal powers to perform any pertinent act to corporate activityin its various manifestations. Limits to the powers conferred have also been established and qualified as internal limits to the rela-tionship between the delegating body of the Board and the parties with delegated powers: theChairman Marco Tronchetti Provera has the power to guarantee Company and subsidiary bondshaving individual values of more than ¤25 million, or for third parties regarding bonds with individ -ual values of more than ¤10 million (in the latter cases another Director’ s signature must be includ-ed with the Chairman’s signature); the General Manager Carlo Buora – as stated, as long as he fillsthis role – has quantitative limits to the powers to make transactions of greater significance (50 mil-lion regarding the undertaking or alienation of interests or shareholdings in companies or bodies,the subscription of capital increases and bonds, the signing of exchange and purchase/sale con-tracts involving real estate assets or financial instruments).Furthermore, the Chairman, Marco Tronchetti Provera, was confirmed as having the following orga-nizational functions:- relations with shareholders and the information provided to them;- coordination of the Managing Directors’ activities;- formulation, in agreement with the Managing Directors, of the general strategies and develop-

ment policy for the Company and the Group, to be submitted to the Board of Directors togetherwith extraordinary corporate actions;

- proposals, to be submitted to the Board of Directors in agreement with the Managing Directors,for the appointment of members of the General Managers’ Departments and, after consulting theRemuneration Committee, for their compensation;

- chairmanship of the managing committees with strategic functions;- all forms of communication to the market, with the right to delegate to the managing directors, in

accordance with what is covered by the procedure for the management and communication tothe market of privileged information, as approved by the Board on March 13th, 2006;

69




- the right to acquire from the Managing Directors and the management of the Group all the dataand information considered necessary to carry out the above-mentioned functions.

Powers pertaining to their specific functions, subject to certain quantitative limits, have been grant-ed to Claudio De Conto4, Chief Operating Officer, and to Luciano Gobbi5, Chief Finance andStrategic Planning Officer6.Less broad powers have been granted to other managers of the Company to be used in their indi-vidual spheres of competence.As in the past, in 2006 the Chairman, the Managing Director (during his mandate), the GeneralManagers and the Managers used their delegated powers only for the ordinary management of theactivities of the Company (in regard to which the directors were periodically informed) and submit-ted the transactions which were more important from an operational or financial perspective to theBoard of Directors.In fact, delegation does not mean the assignment of exclusive powers but is rather the solutionadopted by the Company to ensure, in terms of the organization of the Board, the best degree ofoperational flexibility, both within the Company and in relation to third parties.

1.9 Provision of information to the Board of DirectorsPursuant to Article 11 of the bylaws (which incorporate the prescriptions of Article 150, paragraph1 of the Financial Services Act), the Board of Directors and the Board of Statutory Auditors are keptinformed, inter alia by the persons with delegated powers, about the performance of the Company,its general management, its prospects and the transactions of greatest significance for its profitabil-ity, financial position or assets and liabilities carried out by the Company or its subsidiaries; in par-ticular, such persons report any transactions in which they have an interest, for their own accountor on behalf of third parties, or that are influenced by the person, if any, who performs managementand coordination activities. Such reports are made promptly and at least once every three months,on occasion of the Board of Directors meetings (and the Executive Committee, if established) or bymeans of a written communication.In order to favour the orderly organization of the flow of information, in July 2002, the Companyadopted a procedure with the rules to be followed to ensure compliance with the above-mentionedArticle 150 with regard to the activities of the executive directors, both in exercising their delegat-ed powers and in carrying out the transactions approved by the Board of Directors.This procedure has also recently been subject to a review that involved Company governanceframeworks. The Board of Directors meeting on March 12th, 2007 actually decided to adopt ageneral procedure on information flows to the Directors and Auditors, which incorporates morewidely the procedure adopted to fulfil the obligations of art. 150 of the Financial Services Act.The new procedure aims at regulating and coordinating the various types of data flowing toDirectors and Auditors, so that they all have the common aim of continuously making available tothe members of these Boards the data needed to properly fulfil their directional, policy and controlresponsibilities.The text of this new policy, shown at the end of this chapter, is also available on the website of theCompany at www.pirelli.com, under the sectioned entitled “Governance”.

1.10Rules of conduct for transactions with related partiesThe Company has also established since 2002 the rules of conduct for transactions with related par-ties, including intra-group business. The aim of the rules is to guarantee substantial and procedural

4 Up until November 7th, 2007, General Manager of Administration and Control. 5 Up until November 7th, 2007, General Manager of Finance.6 Similar powers were given to General Manager of the Tires Sector, Francesco Gori, until June 30th, 2006, the date on which hebegan his role with the subsidiary Pirelli Tyre S.p.A., where he is Chief Executive Officer.

70




fairness and transparency of transactions made by Pirelli & C. with parties related to Pirelli & C.,either directly or through subsidiaries.In fact, under the rules, the Board of Directors is required to give advance approval of transactionswith related parties, including intra-group transactions, apart from those of a customary nature andthose to be concluded at standard conditions. To this end, a provision is made for the Board to beadequately informed of all the relevant aspects: the nature of the relationship, the manner of carry-ing out the transaction, the economic and other conditions, the evaluation procedures used, therationale for the transaction and the interest of the Company in its implementation and the associ-ated risks. If the related party is a Director or a party related via a Director, the Director in question– unless the board decides otherwise – may only provide clarifications and must leave the meetingwhen the motion is examined and put to a vote. Depending on the nature, value and other aspectsof related-party transactions, the Board of Directors may be assisted by one or more outside expertsin order to prevent contracts from being concluded at inappropriate conditions. According to thecircumstances, such experts express an opinion on the economic and/or legal and/or technicalaspects of the transaction.Finally, please note that in order to identify what constitutes a related party, the Company – as alsoindicated by Consob – defines the concept of “related party” according to the IAS/IFRS principles(specifically IAS 24). The text of the main principles of conduct is shown at the bottom of this report, and is available onthe website of the Company at www.pirelli.com under the section entitled “Governance”.

2. Committees

2.1 The Remuneration Committee The Board has established, since 2000, the Remuneration Committee from among its members,charged with fact-finding and advisory functions.In line with the provisions in the new Code of Conduct, this Committee:- prepares proposals to the Board regarding the remuneration to the Board of Directors and those

who hold certain roles, to ensure that they align with the objective of shareholder value creationin the medium-long term;

- periodically evaluates the remuneration criteria for the upper management of the Company and,upon request of the Board of Directors, prepares related proposals and recommendations, withspecific reference to the adoption of possible stock option plans or stock bonuses;

- monitors the application of the decisions made by the relevant bodies and company policy regard-ing top management compensation.

The Committee – which may also request the assistance of external consultants in fulfilling its man-date – meets whenever its Chairman deems it appropriate or a meeting has been requested by anoth-er member of the committee or by a Managing Director. The Board of Statutory Auditors and, whenconsidered appropriate, other Company representatives participate in the Committee meetings.In full compliance with provisions in the new Code of Conduct, the Remuneration Committee con-sists exclusively of independent Directors: Berardino Libonati (Chairman), Giampiero Pesenti andAldo Roveri.During 2006, the Remuneration Committee met four times during which it examined – and presentedto the Board – pay packages to the Chairman, the Managing Director (also in reference to the end ofthe mandate regarding the roles covered by the same) and the General Managers, also disclosing thecriteria underlying its decisions. All members of the Remuneration Committee participated in the meetings, except for one absenceduring one meeting.

2.2 The Committee for Internal Control and Corporate Governance The Board has established the Committee for Internal Control and Corporate Governance, which

is charged with fact-finding and advisory functions, from amongst its members since 2000. Inparticular, this committee:a) assists the Board of Directors in establishing the guidelines for the internal control system and

periodically verifying its adequacy and effective working, so as to ensure that the risks facing theCompany are managed appropriately;

b) evaluates the work plan prepared by the persons responsible for internal control, from whom itreceives periodic reports;

c) assesses, together with the financial officers and the independent auditors of the Company, theappropriateness of the accounting standards applied and their homogeneousness for the purposeof preparing the consolidated financial statements;

d) evaluates the proposals made by independent auditors in order to be awarded the appointment,as well as the audit plan and the results set out in the auditors’ report and in the letter of sugges-tions;

e) reports to the Board of Directors at least once every half year, on the occasion of the approval ofthe draft of annual financial statements and the half-yearly report on the activity performed andthe adequacy of the internal control system;

f) performs the additional tasks that may be assigned to it by the Board of Directors, particularlywith regards to relations with the independent auditors; and

g) monitors compliance with the rules of corporate governance and their periodic updating andcompliance with the rules of conduct adopted by the Company and its subsidiaries.

Similarly to the Remunerations Committee, the Board of Directors that convened on March 12th,2007 provided for the adjustment of duties mentioned above to those required in the new Code ofConduct for committees and internal control (art. 8), as well as deciding that the Committee shouldcontinue to maintain the corporate governance prerogatives (see letter g above) that have charac-terised it since its establishment, as well as additionally providing for the following: • that it expresses an opinion on those proposed for election, revocation or assigning of duties to

the internal control provost and the manager proposed as the manager responsible for the prepa-ration of company accounting reports;

• in case of the substitution of an independent Director, it shall propose a candidate to the Boardof Directors for co-optation;

• that it defines the methods and effective times of the Board of Directors annual evaluation.The Committee – which, as it has in the past, may also request the assistance of external consult-ants to fulfil its role – normally meets before the Board of Directors meetings are called for approvalof the draft annual financial statements, the half-yearly report and the quarterly reports; it alsomeets whenever its chairman deems it appropriate or a meeting has been requested by anothermember of the committee or by a Managing Director.The members of the Board of Statutory Auditors, the head of the Internal Control Committee and ifdeemed necessary other company representatives may participate in the meetings of the commit-tee.In line with best practices and in full compliance with the recommendations in the new Code ofConduct for listed companies, the Committee is exclusively composed of the following independ-ent Directors: Carlo Secchi (Chairman), Carlo Angelici and Franco Bruni, two of which7, as ascer-tained by the Board of Directors convened on March 12th, 2007, possess adequate accounting andfinancial experience.During 2006, the Committee for Internal Control and Corporate Governance met seven times andall members participated in these meetings.The Committee actively contributed to the implementation process and the updating of Companycorporate governance instruments. Specifically, following the addition of market abuse regulationsin national law (EU Law 2004), the issuing of the Savings Law, the Corrective Decree and the new

71




7 Mr Bruni and Mr Secchi.

Code of Conduct, the Committee for Internal Control and Corporate Governance in 2006 – availingitself of support from various Company departments – contributed to the defining of a procedurefor the management and the market communication of sensitive information. Moreover, in 2007 ithad already approved the interventions necessary regarding alignment with the new Code ofConduct (as cited throughout this Report), as well as drafting a procedure regarding informationflows to Directors and Auditors, besides formulating proposals for modifications to the Companybylaws and shareholders’ meeting regulations, which will be put forth at the Meeting called toexamine the 2006 financial statements.Also during 2006, the internal control provost of the Company (who is the head of the InternalAuditing Department) was able to refer his actions to the Committee for Internal Control andCorporate Governance through the submission of four reports. The Committee also monitored theactivities carried out by the Internal Auditing Department of the Company, specifically examiningthe result of activities regarding the 2006 Audit Plan and approving the Audit Plan for the financialyear 2007.The Committee was also constantly informed on the auditing activities of the “231 organisationalmodel” and the implementation of the “262 Project” (described below in paragraph 4) and, with therepresentatives of PricewaterhouseCoopers, verified the auditing activities plan.Lastly, it was felt opportune to give an account of the development of the actions, legal and other-wise, that involved two ex-heads of Company Security that were subject to an investigation by theCommittee for Internal Control and Corporate Governance, along with the Board of StatutoryAuditors. Specifically, during the meeting held on July 20th, 2006, the Committee analysed the affair thatinvolved an ex-Manager of the Company, Giuliano Tavaroli – who up until a few years earlier hadbeen the head of the Security Department – in a criminal proceedings case for conspiring to violateprofessional discretion. At this meeting, the Committee was informed of the verification activitiescarried out by the Company with the assistance of legal consultants, as well as the conduct takenin order to ensure a maximum level of collaboration and transparency of the Company regardingthe court of jurisdiction, which – in June 2006 – had deposited a memorandum at the public prose-cutor’s office in Milan (an additional memorandum was thereafter deposited with the national pros-ecutor’s office on December 6th, 2006).During a meeting on September 8th, 2006, the Committee received notice of the outcome of theintrinsic verifications to the passive cycle of the security activities made during the April-May 2006period by the Internal Auditing Department of the Company. This intervention allowed to the iden-tification of some areas of improvement for which corrective actions were held necessary (i.e. thecomplete involvement of the Purchasing Division in security services procurement; the creation ofa suppliers’ registry listing only those who satisfy certain requirements regarding quality, financialreliability and trustworthiness; the establishment of adequate authorisation levels regarding securi-ty service purchase flows; the adoption of additional control measures that guarantee completetraceability for each phase of the purchasing process and the monitoring of the costs of the SecurityDepartment).Subsequently, in October 2006, the Committee – with the assistance of legal consultants that aidedthe Company on this theme – investigated further developments that took place regarding the legalprocess following the injunction issued on September 20th, 2006 by the Preliminary Investigationsat the Court of Milan (which became public domain following the full publication of this provisionon the web site www.ilvelino.it) which remanded in custody Giuliano Tavaroli, as well as PierguidoIezzi (along with others) who at that moment held the role of head of Pirelli & C.’s Security Division.The individuals mentioned above were charged with (i) conspiracy to commit crimes aimed at cor-rupting public officials, using data retrieved from unlawful use of their access to IT systems andembezzlement of Pirelli Group and Telecom Italian funds, (ii) several counts of embezzlement, (iii)corruption of a public official, and (iv) unlawful divulgation of sensitive and reserved information.The Committee specifically examined the position of Pierguido Iezzi since, up until the date of theinjunction, no reasons existed that would lead one to believe or even presume that this individual

72




could have been implicated in the affair and, following the application of precautionary measures,he was suspended from his position as head of Security. Regarding the injunction, the legal consultants of the Company noted that (considering the signifi-cant level of transparency and collaboration shown by the Company, among other reasons) theorder qualified Pirelli as an offended party and therefore subject to damages that occurred due tothe felonies and – as of now – excludes the same from the application of the provisions in legisla-tive decree no. 231/2001 on the administrative responsibility of companies, on the premises (i) thatCompany Top Management was unaware of the felonies, and (ii) according to the fact that thefelonies were committed against, and not in favour, and not even in the interests of the Company.Lastly, the Committee inquired as to the need for corrective actions regarding the internal controlsystem, and acknowledged that the improvements made based on suggestions from an internalaudit on Security functions (which, as mentioned, had already taken place during April and May2006 based on an independent decision of the Company) constituted an adequate solution, despitehaving examined and promoted possible refinements to the system at subsequent meetings.Lastly, during a meeting held on November 6th, the Committee – again discussing the matter – man-dated the Internal Audit Department of the Company to launch the collection of data on the securi-ty service performance required by various company functions during the past few years throughthe initiation of a specific data requirements memo sent to all "front line” Company members. In tan-dem, the Internal Audit Department was also given the task of requiring employees in the Securitydivision of companies in the Pirelli Group to declare if they had or had not kept copies of files ordocuments regarding duties assigned to this Department during the January 2000 – June 2006 peri-od. From initial reports of the verifications made until now – which were still being made during thepreparation of this report – no particular critical findings had come to light. Finally, it should be noted that the Company has launched a civil lawsuit against the security serv-ice suppliers involved in the investigations, in order to be compensated for services that were notcontractually fulfilled or were even illegal.The Committee for Internal Control and Corporate Governance and the Board of Directors, takinginto account the comments of the Board of Statutory Auditors, judged the internal control systemof the Company and of its underlying Group to be adequate.

2.3 Elections CommitteeThe Board of Directors has decided not to establish an election committee charged with putting for-ward proposals for the position of Director, since at present the conditions envisaged by the Codefor its establishment do not exist, because of the current ownership structure and, above all, theBy-laws provision for the slate system, in view of the transparency this mechanism ensures in theselection of candidates.The Board has made the same conclusions also in accordance of provisions in the new Code ofConduct. In fact, since the Board considers the reasons mentioned above still valid, it has not felt that theconstitution of a specific elections committee is necessary. Moreover, it has given the Committeefor Internal Control and Corporate Governance the power to identify candidates to propose to theBoard in the event that an independent Director is to be co-opted.

73




3. Disclosure of sensitive information and insider dealing

3.1 Internal management and disclosure of documents and information Market transparency, clarity, correctness and integrity of information are the values that are upheldby the conduct of the corporate bodies, the management and all the employees of the Pirelli Group. In March 2006, the Board of Directors of the Company adopted a specific procedure for the manage-ment and market communication of sensitive information that, keeping account of the regulationsregarding market abuse, governs the management of sensitive information connected to Pirelli & C.,its unlisted subsidiaries and the listed financial instruments of the Group, and as such all the mem-bers of corporate bodies such as the employees and collaborators of companies external to theGroup that may have access to information that could evolve into sensitive information. This proce-dure also applies as instructions to all subsidiaries in order to obtain from them, without hesitation,the necessary information for the timely and proper fulfilment of financial reporting obligations. This procedure also governs the registration (operative as of April 1st, 2006) of persons havingaccess to privileged information.The adoption of the new procedure is the most evident result of the work done by the workinggroup set up by the Company to assess the consequences of the national regulation (EU Law 2004)implementing the Community Directive on Market AbuseBoth the Committee for Internal Control and Corporate Governance and the Board of StatutoryAuditors were regularly updated on the activity of the working group and agreed with its results.The text of the procedure may be consulted at www.pirelli.com, under the section entitled“Governance”.

3.2 Insider dealingMatters regarding the transparency of transactions on Company shares or financial instrumentsunderlying or linked to shares made directly or by third parties for relevant persons or by personsclosely related or linked to them (i.e. insider dealing) are currently fully governed by law and by reg-ulations established by Consob (art. 114 of the Financial Services Act and art. 152-sexies and fol-lowing amendments of the Issuer's Regulation), as of April 1st, 2006 over-riding the Code of Conductof the Company regarding insider dealing, adopted as from December 2002.Pursuant to the law, irectors and statutory auditors of the Company, as well as “persons who carryout administrative [...] functions in a listed company and managers that have regular access to sen-sitive information [...] and have the power to make management decisions that could affect the per-formance and the future prospects of a listed company…” and others are obliged to disclose to themarket any insider dealing transactions made on Company shares or financial instruments linked tothese shares having a value of more than Euros 5,000 annually. The Company opted to identify thesemanagers as its General Managers, and – as an example of self-regulation – as the ManagingDirector and General Manager of Pirelli Tyre S.p.A. (who, until June 30th, 2006, was the ManagingDirector of the Company). Similarly, disclosure obligations also involve Pirelli & C. Real EstateS.p.A., a company that is also listed on a regulated market.Within the more general auditing process for the corporate governance instruments, despite beingnot obliged by law, the Board of Directors decided to institute a black out period for the personsmentioned above who must adhere to insider dealing regulations; they shall therefore abstain frommaking transactions on Company shares or on financial instruments linked to these shares. Theseperiods may moreover be extended or suspended by the Board of Directors in exceptional cases.

74




4. Internal Control

The internal control system of Pirelli & C. and the Group it heads is designed to ensure theprovision of correct information and adequate cover of all the activities of the Group, with specialreference to those areas that are considered to be potentially at riskIt has developed as a process intended to achieve substantial and procedural fairness,transparency and accountability by ensuring that transactions and, more generally, businessrelated activities are efficient and can be known and verified, that financial information andaccounting and operational data are accurate, that applicable laws and regulations are compliedwith, and that the assets of the business are safeguarded, not least with a view to prevent theperpetration of fraud against the Company and financial markets.The cardinal rules of the internal control system of the Company are:i. separation of roles in the performance of the principal activities involved in each operating

process;ii. traceability and constant visibility of decisions;iii.management of decision-making processes according to objective criteria. Responsibility for the internal control system lies with the Board of Directors, which lays downthe guidelines for the system and periodically verifies that it is adequate and working effective-ly. To this end, the Board refers to the Committee for Internal Control and CorporateGovernance, as well as to a Provost, who is given an adequate level of independence and appro-priate means in order to carry out this mandate, and who carries out typical audit functions toverify the adequacy and efficiency of this system; and, if anomalies are detected, who proposesthe necessary corrective solutions. A specifically nominated Director (currently the Chairman of the Board of Directors) has themandate of identifying the main company risks that must periodically be examined by the Boardand the execution of the policy lines defined by said Board, seeing to the planning, realisationand management of the internal control system, constantly verifying its overall adequacy, effi-ciency and adaptation to the changes in business conditions and legislation and regulation frame-works. The internal control Provost – that the Board of Directors, with the approval of the Committee forInternal Control and Corporate Governance and in accordance with best practice, has identified asthe head of the Internal Audit Department, also deciding his/her remuneration – is functionallyresponsible to the Committee for Internal Control and Corporate Governance and the Board ofStatutory Auditors and hierarchically responsible to the Chairman of Pirelli & C. S.p.A.. The Internal Audit Department has a significantly important role in the internal control system and,also for activities performed regarding subsidiaries, it has the principal task of assessing the ade-quacy and functionality of control, risk management and corporate-governance processes through-out the entire Group by means of autonomous assurance and consultancy. The work of the InternalAudit Department is carried out in accordance with its mandate and is shared with the Committeefor Internal Control and Corporate Governance, regarding the following aspects:• mission;• objectives and responsibilities (independence, complete access to information, activity frame-

work, communication of results);• improvement in the quality of internal audits;• principles of professional ethics;• professional reference standards.The Company also has in place a planning and control system that focuses on individual sectors andoperating units and produces a detailed monthly report for the General Managers, so that they havea useful tool with which to monitor specific activities.In order to favour compliance with the strategies and guidelines adopted by the parent company,the relevant General Managers and senior executives sit on the Boards of Directors of the largestsubsidiaries.

75




Also regarding internal control, please note that – in order to comply with provisions in art. 154-bisof the Financial Services Act (as amended by the Savings Law, and more recently, by the CorrectiveDecree), which does not apply regarding financial statements for 2006 – the Company initiated aproject (named “Project 262”), guided by a specific steering committee, with the objective of mak-ing a system of controls for administrative and accounting procedures available to the administra-tive boards and the managers involved in the preparation of corporate accounts for the preparationand the validation of periodic accounting reports, which allow these individuals to make the decla-rations regarding them as required by law. Please also note that the role of “manager responsiblefor the preparation of company accounting reports” will be introduced into the bylaws by the share-holders at the meeting called to approve the 2006 financial statements. Regarding the detailedreport that will be published for this meeting, please note that the professional requirements of thisnew role will be set in the bylaws (i.e. administrative, financial and control experience); the personoccupying this position will be nominated (and revoked) by the Board of Directors, subject toapproval of the Board of Statutory Auditors, and the Board of Directors will also set the powers andduties for this role.The internal control system described above has been further strengthened by the introduction ofan organizational model that the Board of Directors approved on July 31st, 2003 and which wasrevised and modified according to updated regulations by a resolution of the Board of Directors onMarch 12th, 2007. Intended to ensure the creation of a system responding to the specific require-ments deriving from the entry into force of Legislative Decree 231/2001, on the administrative liabil-ity of companies for criminal offences committed by their employees, the model consists of a set ofprinciples and procedures arranged in a pyramid that, starting from the base, can be summarized asfollows:• Group Code of Ethics, which formulates the general principles (transparency, correctness and

fairness) inspiring the conduct of business. It indicates the objectives and the values informingbusiness activity in relation to the main stakeholders with which Pirelli & C. S.p.A. interacts on adaily basis: the shareholders, the financial market, customers, staff and the community.

• General principles of internal control, which qualify the Internal Control System and the fieldof application, and which extend uniformly across the various organizational levels;

• Lines of conduct, which set out specific rules aiming to avoid the creation of environmental sit-uations that favour criminal activity in general, and in particular, crimes covered under legislativedecree no. 231/2001, and translate the principles established by the Group Code of Ethics intooperational terms.

• Internal control checklists, which set out the main phases of each high and medium riskprocess and of the instrumental processes, the specific checks to be performed with a view to rea-sonably anticipating the risks of any criminal offence, and specify the reports to be transmittedto the Self-Regulatory Body to draw the attention to situations of possible non-compliance withthe procedures established in the organizational model.

A specific Self-Regulatory Body monitors the functioning of and the adherence to the organisation-al model. It is composed of Carlo Secchi, the Lead Independent Director and Chairman of theCommittee for Internal Control and Corporate Governance, Paolo Francesco Lazzati, a member ofthe Board of Statutory Auditors, and Maurizio Bonzi, head of the Internal Audit Department andProvost of internal control. It is also ensured full independence from this Body, as well as havingmany expert professionals that contribute to corporate management control.The Self-Regulatory Body is in charged of making recommendations to the Board of Directors forit to adapt the organizational model to changes in the legal framework, the nature of the businessactivities of the Company and the ways they are conducted. It reports to the Board of Directors, theCommittee for Internal Control and Corporate Governance and the Board of Statutory Auditors onthe checks performed and their results.The shareholders’ meeting of April 28th, 2005 fixed the annual gross fee payable to each member ofthe Self-Regulatory Body at Euros 10,000.

76




With reference to unlisted Italian Group companies, the Self-Regulatory Body has been adapted byadopting the technical and operational solution that, while respecting the mandate and the powersreserved to the body by law, is appropriate to the size and organizational context of each company.A disciplinary system has been introduced to sanction non-compliance with the measures indicat-ed in the organizational, operational and control systems.Finally, it should be pointed out that the Internal Audit Department of Pirelli & C. provides, whenrequested by the self-regulatory bodies of Group companies, operative assistance in the manage-ment and analysis of information flows established pursuant to Art. 6, paragraph 2, letter d), ofLegislative Decree 231/2001, as well as in implementation of specific audits on the basis of datareceived through the aforementioned information flows.During the second half of the year, the Self-Regulatory Body became involved in the court case thatimplicated two ex-heads of the Security Department of the Company, as detailed more extensivelyin paragraph 2.2 above. The Self-Regulatory Body acknowledged that the injunction issued onSeptember 20th, 2006 for the Preliminary Investigations of the Court of Milan (which, as stated,became public domain following the full publication of this provision on the web sitewww.ilvelino.it) which remanded in custody Giuliano Tavaroli, as well as Pierguido Iezzi who atthat moment held the role of head of Pirelli’s Security Division, qualified Pirelli as an offended partyand therefore subject to damages that occurred due to the felonies committed and – in the currentstate – excludes it from the application of the provisions in legislative decree no. 231/2001 on theadministrative responsibility of companies, on the premises (i) that Company Upper Managementwas unaware of the felonies, and (ii) according to the fact that the felonies were committed against,and not in favour, and not even in the interests of the Company. As mentioned, the Board of Directors and the Committee for Internal Control and CorporateGovernance believe that the internal control system of the Company and of the Group is adequate,following evaluations made based on indications received from the Board of Statutory Auditors andother information.

5. Relations with institutional investors and other shareholders

In line with its tradition of transparency and fairness, the Company actively promotes relationswith shareholders, institutional and private investors and with financial analysts, with othermarket operators and with the financial community in general within the proper limits of theirrespective roles, and periodically organizes meetings with representatives from the Italian andinternational financial communities. In March 1999, the Company established an Investor Relations Department to foster continuousdialogue with the financial market. The Investor Relations Department, which reports directly toFinance and Strategic Planning Managing Director Carlo Buora, is headed by Alberto Borgia andhas its own section in the website of the Company at www.pirelli.com.In this section of the website, investors can find every document of interest published by theCompany, in English as well as in Italian, related to financial reporting (e.g., the annual financialstatements and the half-yearly and quarterly reports) and the corporate governance system of theCompany (e.g., the bylaws, the regulations for Shareholder meetings, the Rules of conduct fortransactions with related parties, the procedure for information flows to Directors and Auditors,the procedure for the management and communication to the public of privileged information andthe minutes of Shareholders’ Meetings). The section also gives access to press releases distributedby the Company and the documentation that the Company makes available to the financialcommunity in presentations and/or meetings and information on the share capital of the Companyand shareholders (including the publication of shareholders’ agreements).Pirelli & C. was one of the first companies in Italy and Europe to publish specific inserts giving

77




economic and financial data in the mass media, as well as one of the first to set up a kit on itswebsite for small investors.Investor queries may be sent to: e-mail: [email protected]; tel.: +39 02 64422949; fax: +39 02 64424686.

6. Shareholders’ Meetings

It is the constant policy of the Company to use Shareholders’ Meetings to communicateinformation on the Company and its prospects to the shareholders. Obviously, it does this inaccordance with the rules governing confidential information and, where necessary,simultaneously communicates the same information to the market.The Company carefully considers the choice of the place, date and time for conveningShareholders’ Meetings, to facilitate the participation of the shareholders. All the Directors and allthe members of the Board of Statutory Auditors make every possible effort to attend themeetings, especially those Directors whose positions permit them to make an importantcontribution to the discussion.Moreover, in coherence with the bylaws that facilitates corporate involvement by minimisingcosts and charges, during 2005 article 7 (Shareholders’ Meetings) in the Company Bylaws wasmodified to allow intervention in Shareholders’ Meetings through the notice of intention, withoutthe party concerned needing to produce any certification. At the Meeting held on April 21st, 2006, in addition to approving the 2005 financial statements,shareholders deliberated to renew the mandate of the Board of Statutory Auditors (as detailedbelow) and authorised the purchase and alienation of ordinary and/or savings Company shares,within legal limits, for a period of 18 months.

7. Auditors

The Company bylaws provide that the Board of Statutory Auditors consists in three StandingAuditors and two Alternate Auditors. In order to allow minority shareholders to elect oneStanding Auditor and one Alternate, Article 16 of the bylaws provides for use of the slate system,with one Standing Auditor and one Alternate elected from the slate that obtains the secondlargest number of votes (the minority slate). The other two Standing Auditors and the otherAlternate are elected from the slate that obtains the largest number of votes (the majority slate).Shareholders who, alone or together with others, hold at least 2 per cent of the share capitalentitled to vote at the ordinary shareholders’ meeting, may present slates, subject to their provingownership of the necessary number of shares not later than two days before the date set for theshareholders’ meeting at the first call. Each shareholder may present or participate in thepresentation of only one slate.The slates, signed by the persons who present them, shall be deposited at the registered office ofthe Company at least ten days before the date set for the shareholders’ meeting at the first calland made available to anyone who requests a copy. The slates must be accompanied by aprofessional curriculum vitae for each candidate and declarations in which the candidatesindividually accept their candidacy and attest, on their own responsibility, that there are nogrounds for ineligibility or incompatibility, and that they meet the requirements prescribed by lawand the bylaws.Slates presented in violation of the above rule are considered null.Subject to ineligibility, each candidate may only appear on one slate.Slates must be divided into two sections: one for candidates for the position of Standing Auditorsand the other for candidates for the position of Alternate. The first candidate in each section mustbe selected from among persons entered in the register of statutory auditors who have worked onstatutory audits for a period of not less than three years.

78




Each person entitled to vote may vote for only one slate.Additionally, according to the Company bylaws, the chairmanship of the Board of StatutoryAuditors is to be given to the statutory auditor at the top of the slate which obtains the largestnumber of votes.This clause – as detailed below – was not applied at the renewal of the mandate of the Board ofStatutory Auditors resolved by the Shareholders’ Meeting on April 21st, 2006, in that it wentagainst the provision in art. 148 of the Financial Services Act as amended by the Savings Law,which stipulates the election of the Chairman from amongst the minority members. In the event of death, resignation or disqualification of a Standing auditor, he (or she) is replacedby the alternate director elected on the same slate. If the Chairman of the Board of StatutoryAuditors is replaced, the other Standing Auditor elected on the same slate takes the Chair (see thenote at the end of this paragraph); if it is not possible to proceed in the manner described above,a shareholders’ meeting is called to fill the vacancy or vacancies by means of a resolutionapproved by a relative majority of the votes cast.When the shareholders’ meeting has to appoint Standing Auditors and/or Alternates to bring theboard up to full complement as provided for above or in conformity with the applicable law, itproceeds as follows: if statutory auditors elected from the majority slate are to be replaced, theappointment is made with the favourable votes of a relative majority without being tied to a slate;if, instead, statutory auditors elected from the minority slate are to be replaced, the shareholders’meeting replaces them with the favourable votes of a relative majority, choosing where possiblefrom among the candidates on the slate from which the statutory auditor to be replaced waselectedIn appointing statutory auditors who, for any reason, are not appointed following the procedurespecified above, the shareholders’ meeting votes according to the majorities required by law.Statutory auditors whose term of office has expired may be re-elected. Participation in meetings of the Board of Statutory Auditors may be – if the Chairman or hissubstitute verifies the necessity – by means of telecommunication techniques that permitparticipation in the discussion and equality of information for all those taking part.The Board of Statutory Auditors instated until April 21st, 2006 was composed of Standing AuditorsLuigi Guatri (Chairman), Roberto Bracchetti and Paolo Francesco Lazzati. Franco Ghiringhelli and Sebastiano Guido were both Alternate AuditorsThe Shareholders’ Meeting held on April 21st, 2006 resolved to renew this Board for the 2006-2008period, nominating Luigi Guatri, Enrico Laghi and Paolo Francesco Lazzati as Standing Auditors.Luigi Guerra and Franco Ghiringhelli were appointed Alternate Auditors.The election took place through a slate vote. The members of the Pirelli & C. block sharessyndicate presented the sole slate. The level of authority and the reputation of the candidatesproposed on this list are believed by the Company to be a possible reason why no otheralternative slate was presented by the minority shareholders. Lacking any Auditors on the Statutory Board chosen from the minority slate, the Shareholdersresolved to confirm Luigi Guatri as Chairman of this Board.The Shareholders also resolved that Euros 41,500 be the gross annual remuneration for each ofthe Standing Auditors, and Euros¤62,000 be the gross annual remuneration for the Chairman ofthe Board of Statutory Auditors, also resolving that to the Auditor that is appointed to the Self-Regulatory Body as per legislative decree no. 231/2001 (Paolo Francesco Lazzati) is granted anadditional gross annual remuneration of Euros¤10,000. During 2006, the Board of Statutory Auditors held 4 meetings prior to April 21st, 2006 and another4 following that date. All members of this Board took part in these meetings except for oneabsence in two meetings; please also note that the members of this Board also attended theShareholders’ Meetings and the meetings of the Board of Directors of the Company and all sevenof the meetings that were held during the year for the Committee for Internal Control andCorporate Governance, and all four of the Remuneration Committee meetings, as required by thecorporate governance rules adopted by the Company, which offer the Board of Statutory Auditors

79




the full possibility of directly following the activities of the Committees and performing thecontrol functions of their role with greater efficiency.In line with provisions in the new Code of Conduct (art. 10) and as expressly ascertained by theBoard of Statutory Auditors, all Auditors may be defined as independent based on criteriacontained in the new Code of Conduct regarding directors.In order to conform the Company Bylaws’ provisions relevant to the appointment of the Board ofStatutory Auditors to the new regulations introduced in the Financial Services Act by the SavingsLaw and the Corrective Decree, as well as to the provisions of the new Code of Conduct, theBoard of Directors held on March 12th, 2007 resolved to propose at the Shareholders’ Meetingsome amendments to the Bylaws, i.e.: (i) to eliminate the clause which limits the total number ofoffices a Board member may hold (ii) to amend the clause relevant to the election system of theChairman of the Board of Statutory Auditors, (iii) to increase the period within which slates maybe presented to 15 days, (iv) to align the percentage of corporate shareholdings required topresent slates to the percentage required in the nomination of the Board of Directors, and (v) torequire in any case that each candidate declare all offices held in management and supervisorybodies held in the past, filing such a list at the registered office together with their curriculumvitae.

The following tables summarise all the methods by which the main recommendations of the newCode of Conduct were adopted by the Company: • Structure of the Board of Directors, the Remuneration Committee and the Committee for Internal

Control and Corporate Governance • Structure of the Board of Statutory Auditors• Other provisions in the Code• Offices held in management and supervisory bodies by members of the Board of Directors and

the Board of Statutory Auditors in other listed companies, in financial companies, banks, insur-ance companies, or in other companies of significant size.

80




Table 1 STRUCTURE OF THE BOARD OF DIRECTORS AND THE BOARD COMMITTEES

Board of Directors (1) Committee for RemunerationInternal Control Committee

Position Name executive non-executiveindependent(2) **** Number *** **** *** ****of other

positions **Chairman Marco Tronchetti Provera X 100% 6Deputy Chairman Alberto Pirelli X 100% 6Deputy Chairman Carlo Alessandro Puri Negri X 90% 11Director Carlo Acutis X X 60% 10Director Carlo Angelici (*) X X 90% 1 X 100%Director Gilberto Benetton X 60% 11Director Alberto Bombassei X X - 3Director Franco Bruni (*) X X 90% 3 X 100%Director Gabriele Galateri di Genola X 90% 11Director Mario Garraffo (*) X X 90% 2Director Dino Piero Giarda X X 50% 2Director Berardino Libonati X X 100% 6 X 100%Director Giulia Maria Ligresti X 80% 11Director Massimo Moratti X 30% 6Director Giovanni Perissinotto X 40% 13Director Giampiero Pesenti X X 70% 12 X 75%Director Aldo Roveri (*) X X 100% - X 100%Director Carlo Secchi X X 100% 4 X 100%Director Paolo Vagnone X 60% 3Managing Director Carlo Buora (1) X 89% -Director Carlo De Benedetti (1) X X 67% -Number of meetings held during the year Board of Directors: Committee for Internal Control: Remuneration Committee:(the data refer to the entire financial period): 10 7 4

LEGEND* Indicates that the director was elected from a slate presented by a minority shareholders (quorum required: 2% of voting stock). ** The positions held on the Board of Directors or Statutory Auditors of other companies listed on Italian and foreign regulated markets, of financial banking and insurance companies, and of

other large companies are shown in detail in the Report on Corporate Governance.*** The “X” in one of these columns indicates membership in the relevant Board Committees.**** Indicates the attendance of directors at the meetings of the Board of Directors and the Board Committees.(1) Changes occurred during the 2006 fiscal year: (i) Mr. Carlo De Benedetti has held the position of director until May 5th, 2006, (ii) Mr. Alberto Bombassei has held the position of director as

from September 12th, 2006, and (iii) Mr. Carlo Buora has held the position of director until November 6th, 2006.(2) All the directors eligible for the independent requirement provided by the new Self-Regulatory Code have further declared to be eligible for the independence requirement requested by the

article 147-ter, comma 4 of d. Lgs. 58/1998.

81


Table 2BOARD OF STATUTORY AUDITORS

Position Name Attendance at Number of otherBoard meetings appointments**

Chairman Luigi Guatri 87,50% 16Auditor Enrico Laghi 75% 19Auditor Paolo Francesco Lazzati 100% 23Number of meetings held during the relevant fiscal year: 8 (of which 4 before April 21, 2006)Quorum required for the presentation of slate by minority shareholders for the election of one or more auditors: 2% LEGEND* Indicates that the director was elected from a slate presented by minority shareholders (quorum required: 2% of voting stock).** Indicates the number of the main appointments of statutory auditors or director of other companies, including those held in the Pirelli Group. In the Report on Corporate Governance, these

appointments are shown in detailed.(1) IThe information of the chart refer to the Board of Statutory Auditors appointed on April 21st, 2006. The prior Board of Statutory Auditors was composed as follows: Luigi Guatri (Chairman),

Roberto Bracchetti and Paolo Francesco Lazzati (Acting Auditors), Franco Ghiringhelli and Sebastiano Guido (Alternate Auditors). Prior to April 21st, 2006, 4 meetings of the Board of StatutoryAuditors were held with an aggregate attendance rate of approximately 92%. The information of the chart relating to the attendance of the Professor Luigi Guatri and Mr. Paolo FrancescoLazzati also take into account the meetings held prior to April 21st, 2006.

82




Table 3OTHER PROVISIONS OF THE SELF-REGULATORY CODE

YES NO Summary reasons fordivergence from therecommendations

of the CodeDelegated powers and transactions with related partiesThe Board of Directors has delegated powers and established:a) the limits to such powers? Xb) the manner of exercising them? Xc) the frequency of reports? XHas the Board reserved the right to examine and approve transactionshaving a significant impact on the profitability, the assets and the liabilities or financialposition of the Company (including transactions withrelated parties)? XHas the Board established guidelines for identifying“significant” transactions? XAre the above guidelines described in the report? XHas the Board established special procedures for examining andapproving transaction with related parties? XAre the procedures for approving transaction with relatedparties described in the report? X

Procedures used for the most recent appointments of theBoard of Directors and the Board of AuditorsWere the nominations to the board of directors filedat least ten days in advance? XWere the nominations to the board of directors accompaniedby detailed information? XWere the nominations to the board of directors accompaniedby an indication as to whether they qualified as independent? XWere the nominations to the board of statutory auditors filedat least ten days in advance? XWere the nominations to the board of statutory auditorsaccompanied by detailed information? X

Shareholders’ meetingsHas the Company approved rules of proceedingfor shareholders’ meetings? XAre these rules included in the report(or does the report indicate where they can be obtained/downloaded)? X

Internal controlHas the Company appointed the persons responsible for internal control? XAre such persons hierarchically independent from the headsof the operating units? XUnit responsible for internal control (ex Art. 9.3 of the Code) X

Investor relationsHas the Company appointed a person to be responsiblefor investor relations? XUnit and contact details of the person responsible for investor relations. X1

1 Investor Relations Department (directly under General Manager Finance and Strategic Planning), headed by Alberto Borgia;Contact details: e-mail [email protected]; tel.: +39.02.64422949; fax: +39.02.64424686.

Marco Tronchetti Provera

Alberto Pirelli

Carlo Alessandro Puri Negri

Carlo Acutis

Carlo Angelici

Gilberto Benetton

Alberto Bombassei

Camfin S.p.A.Gruppo Partecipazioni Industriali S.p.A.Olimpia S.p.A.Pirelli & C. Real Estate S.p.A.Pirelli Tyre S.p.A.Marco Tronchetti Provera & C. S.a.p.a.

FIN.AP di Alberto Pirelli & C. A.p.A.Gruppo Partecipazioni Industriali S.p.A.Camfin S.p.A.GIM S.p.A KME S.p.A.Pirelli Tyre S.p.A.

Pirelli & C. Real Estate Franchising Holding S.r.l.Pirelli & C. Real Estate Opportunities Società diGestione del Risparmio S.p.A.Pirelli & C. Real Estate Società di Gestione delRisparmio S.p.A.Camfin S.p.A.Pirelli & C. Real Estate S.p.A. Gruppo Partecipazioni Industriali S.p.A.Aon Italia S.p.A.Eurostazioni S.p.A.Olimpia S.p.A.Pirelli Tyre S.p.A.Telecom Italia S.p.A.

BPC Investimenti SGR S.p.A.Vittoria Capital N.V.Banca Passadore & C. S.p.A.Vittoria Assicurazioni S.p.A.Camfin S.p.A.Ergo Assicurazioni S.p.A.Ergo Italia S.p.A.Ergo Previdenza S.p.A.IFI S.p.A.Yura International B.V.

Stretto di Messina S.p.A.

Autogrill S.p.A.Edizione Holding S.p.A.Ragione Sapa di G. Benetton e C.Olimpia S.p.A.Telecom Italia S.p.A.Aldeasa S.A.Autostrade S.p.A.Benetton GroupLoyd Adriatico S.p.A.Mediobanca S.p.A.Schemaventotto S.p.A.

Brembo S.p.A.Autostrade S.p.A Italcementi S.p.A.

ChairmanChairman ChairmanChairmanChairmanMember of the Board of Managing Partners

Chairman Deputy ChairmanDirectorDirectorDirectorDirector

ChairmanChairman

Chairman

Deputy ChairmanDeputy Chairman and Managing DirectorManaging DirectorDirectorDirectorDirectorDirectorDirector

ChairmanChairman Deputy ChairmanDeputy ChairmanDirectorDirectorDirectorDirectorDirectorDirector

Director

ChairmanChairmanChairmanDeputy ChairmanDeputy ChairmanDirectorDirectorDirectorDirector DirectorDirector

ChairmanDirectorDirector

83




Posts of Director or Statutory Auditor held by members of the Board of Directors ormembers of the Board of Statutory Auditors in other listed companies, in financialcompanies, banks, insurance companies or companies of significant size

84




Franco Bruni

Gabriele Galateri di Genola

Mario Garraffo

Dino Piero Giarda

Berardino Libonati

Giulia Maria Ligresti

Massimo Moratti

Giovanni Perissinotto

Pioneer Global Asset Management S.p.A.Unicredito Banca Mobiliare S.p.A.Unicredit Audit S.p.A.

Mediobanca S.p.A.Istituto Europeo di Oncologia S.r.l.Assicurazioni Generali S.p.A.RCS MediaGroup S.p.A.Accor SABanca CRS S.p.A.Banca Esperia S.p.A.Fiera di Genova S.p.A.Italmobiliare S.p.A.San Faustin NVCommerzbank AG

Recordati S.p.A.Terna S.p.A.

Banca Popolare Italiana S.p.A.ACEA S.p.A.

Alitalia S.p.A. Banca di Roma S.p.A.UnidroitMediobanca S.p.ANomisma S.p.A.RCS Mediagroup S.p.A.

Fonsai MB&A S.p.A.Premafin Finanziaria Holding di Partecipazioni S.p.A.Fondiaria Sai S.p.A.Sai Holding Italia S.p.ASaifin S.p.A Finadin S.p.A.Milano Assicurazioni S.p.A.Sailux S.A.Sainternational S.A.Telecom Italia Media S.p.A.Helm Finance SGR S.p.A.

F.C. Internazionale Milano S.p.A.Sarint S.A.Angelo Moratti di Gian Marco e Massimo Moratti & C. S.a.p.a.Interbanca S.p.A.Saras S.p.A. Raffinerie SardeTelecom Italia S.p.A.

Banca Generali S.p.A.Generali Finances S.A.Generali Investments S.p.A. SGRGenerali Property S.p.A.Banca della Svizzera Italiana S.A.Alleanza Assicurazioni S.p.A.Generale Espana Holding de Entidades de SegurosGenerali France HoldingGenerali Property Investments Sgr S.p.A.Ina Assitalia S.p.A.Toro Assicurazioni S.p.A.Partecipatie Maatschappij Graafschap Holland N.V.Intesa San Paolo S.p.A.

Director DirectorDirector

ChairmanChairmanDeputy Chairman Deputy Chairman DirectorDirectorDirector DirectorDirectorDirectorMember of the Central Advisory Board

DirectorDirector

ChairmanDirector

ChairmanChairmanChairman DirectorDirectorDirector

ChairmanChairman and Managing DirectorDeputy Chairman Managing DirectorManaging DirectorDirectorDirectorDirectorDirectorDirectorDirector

ChairmanChairmanMember of the Board of Managing Partners

DirectorManaging DirectorDirector

ChairmanChairmanChairmanChairmanDeputy ChairmanDirectorDirectorDirectorDirector DirectorDirectorDirectorMember of the Management Board

85




Giampiero Pesenti

Aldo Roveri

Carlo Secchi

Paolo Vagnone

Luigi Guatri

Enrico Laghi

Italcementi S..A.Franco Tosi S.r.l.Italmobiliare S.p.A.Ciments FrancaisFincomind AGCiments de MarocCompagnie Monegasque de BanqueCredit Mobilier de MonacoFinter Bank ZurichSoparfinter S.A. LuxembourgMittel S.p.A.R.A.S. S.p.A.

-

Lloyd Adriatico S.p.A.Mediaset S.p.A.Parmalat S.p.A.R.A.S. S.p.A.

R.A.S. S.p.A.

Mol Holding S.p.A.UniCredito Italiano

Banche Popolari Unite S.c.p.A.Centrobanca S.p.A.Italmobiliare S.p.A.Movi Lemar S.p.A.Movi S.p.A.Permasteelisa S.p.A.Rhifim S.p.A.Wimed S.p.A.Granitifiandre S.p.A.Finanziaria 2000 S.p.A.Vittoria Assicurazioni S.p.A.Maffei S.p.A.Negri Bossi S.p.A.Banco di Desio e della Brianza S.p.A.Medinvest Int. ScAAcbgroup S.p.A.

Alitalia Servizi S.p.A. Raffineria di Gela S.p.A.Sarda Bitumi – Sarbit S.p.A.Alitalia – Linee Aeree Italiane S.p.A.01 Distribution S.r.l Gruppo Editoriale Espresso S.p.A.Iridium S.p.A. – in liquidazioneLoquendo S.p.A.Servizi Aerei S.p.A.Rainet S.p.A.TM News S.p.A.IT Telecom S.r.l.Manzano Sviluppo S.r.l. Beni Stabili Investimenti SGR S.p.A.FdP Consulting S.r.l.Europrom 2000 S.r.l.Banca Finnat Euroamerica S.p.A.Beni Stabili S.p.A.Nomura SIM Italia S.p.A.

ChairmanChairman Chairman and Managing DirectorDeputy Chairman Deputy ChairmanDirectorDirectorDirectorDirectorDirectorDirectorDirector

-

DirectorDirectorDirectorDirector

Managing Director and GeneralManagingDirector Director

Chairman Board of Statutory AuditorsChairman Board of Statutory AuditorsChairman Board of Statutory AuditorsChairman Board of Statutory AuditorsChairman Board of Statutory AuditorsChairman Board of Statutory AuditorsChairman Board of Statutory AuditorsChairman Board of Statutory Auditors Chairman Board of Statutory Auditors Chairman Board of DirectorChairman Board of DirectorDirectorDirectorDirectorMember of Supervisory BoardChairman of the Supervisory Board

Chairman Board of Statutory AuditorsChairman Board of Statutory AuditorsChairman Board of Statutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsChairman Board of DirectorSole DirectorSole DirectorDirectorDirectorDirector

86




Paolo Francesco Lazzati Amiata Energia S.p.A.Baleri Italia S.p.A.Capitolotre S.p.A.Giangiacomo Feltrinelli Editore S.r.l.IVRI Direzione S.p.A. - MilanoPirelli Tyre S.p.A.Pre Agency S.p.A.Antonio Cerruti & C. S.a.p.a.Cam Partecipazioni S.r.l.Credito Artigiano S.p.A.Dear S.p.A.Effe 2005 Finanziaria Feltrinelli S.p.A.Elesa S.p.A.Erogasmet Holding S.p.A ICBPI S.p.A.Ilma Plastica S.p.A.Kedrios S.p.A.Lanificio F.lli Cerruti S.p.A.Librerie Feltrinelli S.r.l.Pirelli & C. Real Estate Opportunities SGR S.p.A.Pirelli & C. Real Estate SGR S.p.A.Prysmian S.r.l.Fnaval S.r.l.

Chairman Board of Statutory AuditorsChairman Board of Statutory AuditorsChairman Board of Statutory AuditorsChairman Board of Statutory AuditorsChairman Board of Statutory AuditorsChairman Board of Statutory AuditorsChairman Board of Statutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsStatutory AuditorsDirector

Procedure for information flows to directors and auditors

1. Introduction

1.1 – The completeness of the available information to directors is essential for the proper fulfilment oftheir duties and responsibilities regarding the management, the direction and the monitoring of the busi-ness activities of Pirelli & C. S.p.A. (henceforth “Pirelli” or “the Company”) and of the Group.1.2 – Similar appropriate information is due to the Board of Statutory Auditors.1.3 – In compliance with the legal and the bylaws’ provisions, non-executive Directors and Auditorsare therefore the receivers of a permanent information flows from the Executive Directors, who arecoordinated by the Chairman of the Board of Directors who, if necessary, can refer to the Secretaryto the Board of Directors of the Company.1.4 – The purpose of the current procedure is to regulate the above-mentioned information flows inorder to:• guarantee the transparency of the management of the Company;• ensure good conditions for efficacious and effective actions of direction and monitoring of the

Company activities and management by the Board of Directors;• supply the Board of Statutory Auditors with the requisite tools for an efficient fulfilment of its role.

2. Terms and procedures

2.1 – The information flows to Directors and Auditors is preferably provided with written documents,specifically: • notes, memoranda, presentations and reports drawn up by Company offices or consultants,

including those prepared for Board of Directors meetings; • other documents, published and un-published, available to the Company; • documents of accounting period of the Company that are intended for publication;• quarterly financial reports including external information, drawn up according to specific guidelines. 2.2 – The above-mentioned documentation is timeless transmitted to non-executive Directors andAuditors and, in any case: • with a sufficient frequency in order to ensure that legal and bylaws data provisions are respected, • according to coherent deadlines with the scheduling of the single Board of Directors meeting.2.3 – The information reproduced according to the procedures above are integrated (or, if necessary,omitted for reasons of privacy) with the comments made orally by the Chairman, the ExecutiveDirectors or by members of the management of the Group during Board of Directors meetings or spe-cific informal meetings, open to Directors’ or Auditors’ participation, and organized in order to go intotopics about the management of the Company.2.4 – The transmission of documents and any other material to Directors and Auditors is coordinatedby the Secretary to the Board of Directors of the Company, in agreement with the manager in charge ofthe preparation of the accounting documents of the Company, as per his competence.2.5 – In any case, Directors and Auditors are the receivers of the information published by Pirelli as pro-vided by legal provisions regarding Company reports (such as press releases and reports) and invest-ment solicitation (reports that are denominated, anyhow).

3. Contents

3.1 – The information flow to Directors and Auditors – besides matters intended for the examinationand/or the approval of the Board of Directors of the Company according to the law and the bylaws ofthe Company – includes: • the general results of operations and their foreseeable development;

87




• the completed activity, with specific reference to transactions involving significant economic,financial and equity income, to transactions with related parties and to atypical or unusualtransactions;

• the instructions given during the execution of direction and coordination activities;• any further activities, transactions or events that are deemed appropriate to bring to the attention of

Directors and Auditors.

4. General results and development of operations

4.1 – The corporate activities of the Group are the focus of background information about management. 4.2 – Information are considered in a strategic perspective of planning and direction, as well as in termsof the attainment of results and in comparison with industrial and budget forecasts. 4.3 – General results and development of operations are regularly examined by the Board of Directorsof the Company when they approve the accounting period reports. The attained results are compared: • with historic figures (opportunely reconstructed using pro forma figures in order to obtain

homogeneous comparisons with previous periods); • with budget objectives, indicating the causes of possible variances, also in order to evaluate the

effects of these variances on strategic or anticipatory objectives and/or on forecasts regardingfollowing periods;

• with the general trend of the sector and peers, in order to benchmark.

5. Business activity

5.1 – General information about the completed business activity concern executive businesses anddevelopments of operations already decided by the Board of Directors, as well as activities performedby Executive Directors – also through units and subsidiaries of the Company – in the exercise of theirduties.5.2 – General information about the business activities are completed with a specific report of detailsregarding:• transactions involving significant economic, financial and equity income; • operations with related parties; • atypical or unusual transactions.

6. Significant transactions

6.1 – The following – besides operations reserved to the Board of Directors according to the art. 2381of the Italian Civil Code and the bylaws of the Company – are considered transactions involving signif-icant economic, financial and equity income when Pirelli or subsidiaries carry out:• the issues of financial tools for a total value higher than Euros 100 million;• the granting of personal and collateral securities in the interest of subsidiary companies (and in the

interest of Pirelli regarding collateral securities) against bonds having a unit value higher than Euros25 million;

• the granting of loans or securities in favour or in the interest of third parties for amounts higherthan Euros 10 million;

• the granting of loans in favour of subsidiary companies and the investment or disinvestmenttransactions, also real estate transactions, transactions for the purchase and the assignment ofshare, of company and company branches, of assets and other activity, for amounts higher thanEuros 100 million;

• merger and division transactions, when at least one of the parties is a listed company or whensubsidiary companies are involved if at least one of the parameters indicated below, in case ofapplication, come out equal or higher than 15% of:

88




– the total assets of the merged company or of the activities submitted to division/the total assets ofthe Company (figures taken from the consolidated balance sheet, if reported);

– the pre-tax results and the extraordinary parts of the merged company, or of the activities to bedivided/the pre-tax results and extraordinary parts of the Company (figures taken from consolidat-ed balance sheet, if reported);

– the total equity capital of the merged company, or of the company branch submitted to division/thetotal equity capital of the Company (figures taken from consolidated balance sheet, if reported).

6.2 – Informative report on transactions involving significant economic, financial and equity incomeshall highlight the strategic aims, the budget and the industrial plan coherence, the executive proce-dures (including economic terms and conditions for their fulfilment), the business developments as wellas the possible changes and implications for the activities of the Pirelli Group.6.3 – Informative reports shall also be made for transactions that, even if they are individually smallerthan the above-mentioned threshold value, are associated within the same strategic plan or executiveprogramme and therefore, considered altogether, exceed the threshold value.

7. Operations with related parties

7.1 – The following definitions must be made regarding the current procedure relating to “related par-ties”; these are defined according to international accounting standards concerning financial statementsfor transactions with related parties, adopted in accordance with art. 6 of EC Regulation n. 1606/2002.7.2 – The Company adopted this apposite procedure in order to ensure that the principle of fairness wasrespected in substance and form for all transactions made, directly or through subsidiaries, with relat-ed parties with Pirelli7.3 – Besides the transactions with related parties subject to the board approval according to the above-mentioned procedure (atypical, unusual or non-standard transactions), transactions with related infra-Group parties (i.e. companies owned by Pirelli or by the company that owns Pirelli) must be similarlyreported to Directors and Auditors if they involve amounts higher than Euros 50 million, and those withassociated non infra-Group parties if they involve amounts higher than Euros 500.000. For each of thesetransactions, the following points must be indicated: • object and amount;• the date of targeting of the contract(s) below or those linked anyway with the transactions;• the identities of the counterparties (specifying the nature of their relationship with Pirelli).7.4 – As to every quarter of statement, an overall figure of the transactions concluded with the individ-ual parties related to Pirelli must be supplied, separating the transactions directly carried out withPirelli and the transactions achieved by subsidiary companies.

8. Atypical or unusual transactions

8.1 – Transactions that form part of the ordinary business of the Company are considered typical, i.e.essential to the production and the dealing cycle of the Company. On the contrary, transactions are con-sidered usual when intended for the fulfilment of ordinary requirements, i.e. requirements that normal-ly belong to the business of the Company.8.2 – In any case, transactions may be called neither typical nor usual when they actually present par-ticular elements of criticality due to their specific characteristics and/or to their intrinsic risks, to thenature of the counterparty or to the time of their fulfilment.8.3 – Information about atypical or unusual transactions highlight the interest below and illustrate theexecutive procedures (including the economic terms and conditions of their fulfilment), with specificreference to the estimative procedures followed.

89




9. Direction and coordination activities

9.1 – Information about the execution of direction and coordination activities illustrate: • the strategic aims, with specific reference to the entrepreneurial interest justifying them and the

results that are followed;• the executive procedures (including the economic terms and conditions of their fulfilment), with

specific reference to the estimative procedures followed;• the possible changes and implications on the execution of the company, also with reference to the

budget and the industrial plan.9.2 – Further updating on the affected transactions shall be supplied in order to estimate overall resultsof the direction and the coordination activities.

Data collection procedure

In order to allow an adequate information flow to non-executive Directors and to the Board of StatutoryAuditors, information must be obtained by the Chairman and CEOs according to the procedure listedbelow.

1. Information about business activities, about transactions involving significanteconomic, financial and equity income, about infra-group transactions and atypical orunusual transactions.

Pirelli General Managers and the Heads of Business units/Central Functions/Business Operations thatreport directly to the Chairman and the CEOs (the so-called “Front Line”) through the General Managerand Chief Operating Officer transmit, on a quarterly basis, to the Chairman and the CEOs, with an appo-site note, the activities that the competent structure carried out in the period, highlighting specifically thetransactions involving significant economic, financial and equity income; the infra-Group transactionshigher than Euros 50 million; non-standard, atypical or unusual transactions; the executive businessesand developments of operations already decided by the Board of Directors; as well as the main businessactivities carried out within the duties attributed to Managing Directors, including the most importantlaunched projects and the most significant undertaken initiatives.Informative reports shall also be made for transactions that, even if they are individually smaller than theabove-mentioned threshold value, are associated within the same strategic plan or executive programmeand therefore, considered altogether, exceed the threshold value.

2. Information about operations with related parties different than intra-grouptransactions

The purpose of the current procedure are the transactions with related parties carried out by Pirelli orby companies owned by Pirelli, with parties directly or indirectly related to Pirelli.a) the persons who, directly or indirectly, control Pirelli, also in virtue of shareholder agreement, indi-

vidually or jointly with other persons included in these agreements;b) the persons who, directly or indirectly, exercise a significant influence over Pirelli. This influence is

presumed in case of shareholdings equal to or higher than 10% of the authorized capital in the formof ordinary Pirelli shares;

c) the members of the Board of Directors and Acting Auditors of Pirelli;d) the managers with strategic responsibilities in the Company, identified by the Board of Directors of

Pirelli, or in its possible subsidiaries (i.e. “key managers”);e) the immediate family members of the persons indicated in letters c) and d), i.e. spouses and depend-

ents, as indicated in civic records;

90




f) the companies upon which the persons indicated above in letters a) to e) exert control, directly orindirectly, also in virtue of shareholders agreement, individually or jointly with other persons includ-ed in these agreements;

g) the companies on which the persons indicated above in letters a) to e) exert significant influence, ifthey are physical persons. This influence is presumed in case of shareholdings equal to or higher than10% (in the case of listed companies) or 20% (in the case of unlisted companies) of the authorizedcapital in the form of voting shares at the general meetings;

h) the companies in which the persons indicated above in letters a) to e) hold strategic managementroles and the companies controlled by these companies;

i) the joint ventures in which Pirelli participates;j) the pension funds for the employees of Pirelli or of related parties;k) the companies that share a majority of their Directors with Pirelli.

With the same regularity as mentioned under point 1 above, General Operations Management collectsand transmits to the Chairman and to the CEOs declarations from the persons mentioned under lettersa) to d) above pointing out the transactions involving amounts higher than Euros 500.000, or those withlower amounts but non-standard, achieved directly by or through one of the persons indicated in lettersf) to k) above, also through third parties, with Pirelli or its subsidiaries, by themselves or, in the case ofphysical persons, by spouses or dependents, as indicated in civic records.

Amongst these information, must be pointed out transactions that, even if they are individually smallerthan the above-mentioned threshold value, are associated within the same relation and therefore, con-sidered altogether, exceed the threshold value.

General Operations Management also collects the declarations whereby the persons in letters a) to d)above: (i) list the companies for which they perform the cases in letters f) to j) above, as well as com-panies in which they hold the role of directors; (ii) update this list.

General Operations Management transmits the list to the parties related to Pirelli as specified above tothe General Managers and to the Front Line.

The Front Line communicates on a quarterly basis to the Chairman and the CEOs the transactions com-pleted with Pirelli – or companies controlled by Pirelli – also through third parties or indirectly relatedparties as specified in the list given by the General Operations Management, involving amounts higherthan Euros 500,000 and, also if involving lower amounts, made under non-standard conditions.

Rules of conduct for effecting transactions with related parties

1. Transactions with related parties, including intra-group transactions, except for typical or usualtransactions concluded at arm’s length conditions, must be approved in advance by the Board ofDirectors.

2. Typical or usual transactions shall be taken to mean those which, by their object or nature, are notextraneous to the normal course of business of the Company and those which do not involveparticular critical factors due to their characteristics or to the risks related to the nature of thecounterpart or to the time at which they are concluded. Transactions concluded at arm’s lengthconditions means transactions concluded at the same conditions as those applied by the Companyto whatsoever party.

91




3. The Board of Directors shall receive adequate information on the nature of the relationship, themanner of execution of the transaction, the economic and other terms and conditions governing it,the valuation procedure adopted, the underlying interest and motivations, and the possible risks forthe Company. Where the relationship is with a Director or with a party related by means of aDirector, the Director concerned shall limit himself to providing clarifications and shall leave themeeting of the Board when the decision is to be taken; the Board of Directors may also resolve in adifferent way.

4. Depending on the nature, value and other characteristics of the transaction, to guard against thetransaction’s being carried out at unsuitable conditions the Board of Directors shall be assisted byone or more experts, who shall express an opinion, according to the case, on the economicconditions and/or the legitimacy and/or the technical aspects of the transaction.

5. For transactions with related parties, including intra-group transactions, which are not submitted tothe Board of Directors inasmuch as they are typical or usual concluded at arm’s length, theDirectors having delegated powers or the managers responsible for carrying out the transaction,without detriment to compliance with the specific procedure pursuant to Article 150.1 of theConsolidated Law on Financial Intermediation, shall collect and preserve, inter alia by type or groupof transaction, adequate information on the nature of the relationship, the manner of execution ofthe transaction, the economic and other terms and conditions governing it, the valuation procedureadopted, the underlying interest and motivations, and the possible risks for the Company. For suchtransactions also, one or more experts may be appointed as provided above.

6. The experts are to be chosen from among persons of recognized professional experience andcompetence in the matters concerned. Their independence and absence of conflicts of interest willbe carefully evaluated.

92




Abridged form of Pirelli & C. Società per AzioniShareholders Agreement

1. Type and objective of the agreement The purpose of the Pirelli & C. shareholders agreement is to ensure a stable shareholder base and auniform strategy in the management of the company.

2. Parties to the shareholders agreement and Pirelli & C. shares transferred to the agreement:

Number of % of all shares % of the total Shares granted granted n. of ordinary

shares issued

CAMFIN S.p.A. 1,027,455,727 42.48 19.63

MEDIOBANCA S.p.A. 233,001,859 9.63 4.45

EDIZIONE HOLDING S.p.A. 232,992,911 9.63 4.45

FONDIARIA - SAI S.p.A. 223,543,498 9.24 4.27

RAS S.p.A. 222,958,537 9.22 4.26

ASSICURAZIONI GENERALI S.p.A. (*) 222,958,531 9.22 4.26

CAPITALIA PARTECIPAZIONI S.p.A. 81,665,400 3.38 1.56

INTESA SANPAOLO S.p.A. 81,665,400 3.38 1.56

Massimo MORATTI (**) 60,300,084 2.49 1.15

SINPAR HOLDING S.A. - SINPAR S.p.A. (***) 32,048,563 1.33 0.61

Total 2,418,590,510 100.00 46.20

(*) n. 57,400,000 shares through La Fédération Continentale Compagnie d'Assurances Sur La Vie S.A., n. 82,779,265 shares through Ina Vita S.p.A.and n. 82.779.266 shares through Generali Vita S.p.A.

(**) Including 37,420,339 shares through CMC S.p.A. and n. 11,328,318 shares fiduciary owned by Istifid S.p.A. (***) n. 19,797,563 shares of Sinpar Holding S.A. and n. 12,251,000 shares of Sinpar S.p.A.

3. The party, if any, which, through the agreement, can exercise control over the company There is no party which, through the agreement, can exercise control over Pirelli & C..

4. Restrictions on the sale of the shares transferred and on the subscription and the purchase ofnew sharesThe sale of the shares to third parties (and option rights in the event of a capital increase againstpayment) is prohibited. Shares can be sold freely and pre-emptively to subsidiaries, according toarticle 2359, paragraph 1, point 1 of the Italian Civil Code, and to the parent companies as well asother participants to the shareholders agreement.Each participant may buy or sell additional shares for an amount not in excess of the higher of 20%of the shares already transferred by the participant itself and 2% of the ordinary share capital issued;purchases of greater amounts are permitted only with the intent of reaching a holding equal to 5% ofthe ordinary share capital issued, on condition that the amount in excess of the above limits cameunder the shareholders agreement.CAMFIN S.p.A. is authorized to freely purchase additional Pirelli & C. shares; it can transfer shares tothe shareholders agreement, but to the extent that, at any one time, the shares do not exceed 49.99%of total shares transferred by all the participants in the shareholders agreement. This has beendecided so that a stable predominate position is not assumed in the shareholders agreement or astable veto power is not exercised over common decisions.Except where the Pirelli & C. ordinary shares in the shareholders agreement correspond to themajority of the voting rights in the ordinary shareholders’ meetings, each participant (also throughparent companies and/or subsidiaries) intending to purchase shares of that category shall inform thePresident in writing beforehand and the President shall inform the participant if, taking into accountthe laws in force concerning tender offers, the participant can proceed, in whole or in part, with theproposed purchase. Buy or sell the shares.

93




5. Availability of the shares The shares transferred shall remain at disposal of the participants in the shareholders agreement.

6. Bodies governing the agreement, composition, meetings and powers The Body governing the agreement is the Shareholders Agreement Executive Committee.The Shareholders Agreement Executive Committee shall consist of a president and vice-president,in the form of the president and the longest serving vice-president of Pirelli & C., and by a memberrepresenting each participant unless a participant has deposited more than 10% of ordinary sharecapital, in which case another member may be designated: for this purpose, in the event theshareholders agreement is composed of several companies related by a controlling relationship orbelonging to the same parent company, their aggregate shall be considered for this purpose as onesole participant in the shareholders agreement. The Shareholders Agreement Executive Committee shall be convened to evaluate the proposalsto be submitted to the shareholders’ meetings, for the possible earlier termination of the agreementand for the admission of new participants. The Shareholders Agreement Executive Committee shallalso meet at least twice a year to examine the semiannual performance, the annual results,the general guidelines for the company’s development, the investment policy and proposed significantdivestitures and more in general, all the relevant matters of discussion by both the ordinary andextraordinary sessions of the shareholders’ meetings.

7. Matters covered by the agreement Those contemplated in points 4 and 6 above.

8. Majorities needed to reach decisions regarding the issues governed by the agreement The Shareholders agreement Executive Committee approves its resolutions with the favourable voteof the majority of the shares transferred; the Shareholders agreement Executive Committee candesignate a trusted person to represent the shares in the shareholders agreement at the shareholders’meetings in order to vote according to its instructions. Whenever the decisions of the ShareholdersAgreement Executive Committee are not voted unanimously, the dissenting participant shall have theright to freely vote at the shareholders’ meeting.

9. Term, renewal and cancellation of the agreement The agreement shall be valid until April 15, 2010 and shall be tacitly renewed for a period of threeyears except for withdrawal, which can be exercised between December 15 and January 15 prior tothe expiration date. In case of withdrawal, the shares transferred by the withdrawing party shall beautomatically offered pro quota to the other participants. The agreement shall remain in force,whenever it is possible, at every expiration date, to renew the agreement for a percentage of Pirelli &C.’s subscribed ordinary share capital of not less than 33%.

10. Penalties for breach of the commitments contained in the agreementThey are not envisaged by the agreement.

11. Registration of the agreement at the Company Registry The agreement is registered at the office of the Milan Companies Registry.

Milan, 19 January 2007

94




Pirelli & C. S.p.A. - Summary DataBalance sheet and financial position


Property, plant and equipment 103.4 51.7 Intangible assets 1.7 2.5 Financial assets 5,353.2 6,433.8 Net working capital (186.1) (391.3)

5,272.2 6,096.7 Equity 2,882.3 4,661.1 Provisions 221.4 193.4 Net financial (liquidity)/debt position 2,168.5 1,242.2

5,272.2 6,096.7

The above statement presents the balance sheet and financial position of the company. The mostsignificant changes during 2006 refer to the following:

- property, plant and equipment increased by Euros 51.7 million basically as a result of a financelease contract taken on by Pirelli Tyres S.p.A. (Euros 55 million);

- financial assets decreased by Euros 1,080.6 million. An analysis of movements is presented in thefollowing table:

(in millions of euros)Investments:Olimpia S.p.A. 1,139Pirelli Tyres S.p.A. 152Capitalia S.p.A. 38Mediobanca S.p.A. 14Assicurazioni Generali S.p.A. 5

Subscriptions:Banca Leonardo S.p.A. 4

Reimbursements of capital and reserves:Pirelli Tyre Holding N.V. (310)Consortium S.r.l. (15)

Divestitures:Capitalia S.p.A. (178)F.C. Internazionale Milano S.p.A. (11)Assicurazioni Generali S.p.A. (5)

Writedowns:Olimpia S.p.A. (1,827)Pirelli S.A. (12)Pirelli Finance (Luxembourg) S.A. (16)Pirelli Cultura S.p.A. (1)KME Group S.p.A. (5)Euroqube (2)

Measurement at fair value and income (expenses) recognized in income at thetime of sale or in the presence of impairment losses previously recognized in income (50)

Total (1,080)

95


IntroductionThe Group2006 operating andfinancialMajor events in 2006Group consolidationPirelli LabsSignificant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocumentsPirelli TyrePirelli BroadbandSolutionsPirelli & C. Real EstatePirelli & C. AmbienteInformation systemsProforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plansCorporate Governance

A Pirelli & C. S.p.A. -Summary DataShareholders’ Resolutions

- the change in “net working capital” is mainly due to the decrease in liabilities relating to the putoptions granted by shareholder banks of Olimpia (Banca Intesa S.p.A. and UniCredit ItalianoS.p.A.) under the shareholders’ agreements (Euros 233 million). Such liabilities in 2006 show a nilbalance following the right of withdrawal exercised and communicated by the banks in March 2006and which was executed on October 4, 2006 upon the purchase of the investments in OlimpiaS.p.A. on the part of Pirelli & C. S.p.A..

- equity decreased by Euros 1,778.8 million compared to December 31, 2005. The changes in equityare presented in the following table:

(in millions of euros)Equity at December 31, 2005 4,661.1 Dividends paid (113.7)Capital increase due to exercise of warrants 26.8Income (expenses) recognized directly in equity:- Fair value adjustment of available-for-sale financial assets 21.0- Income /expenses recognized in income at the time of sale of available-for-sale

financial assets or in the presence of impairment losses (70.6)Total income (expenses) recognized directly in equity (49.6)Loss for the year (1,642.3)Equity at December 31, 2006 2,882.3

- the net debt position went from a net financial debt position of Euros 1,242.2 million atDecember 31, 2005 to Euros 2,168.5 million at December 31, 2006. A summary of the changes isdetailed in the following table:

(in millions of euros)Net financial debt position at December 31, 2005 1,242.2Financial investments 1,353.0Capital expenditures in property, plant and equipment 55.7Financial divestitures (677.0)Dividends collected (192.8)Dividends paid 113.7Change in net working capital 205.2Other 68.5Net financial debt position at December 31, 2006 2,168.5

Income statement


Financial income (expenses) 58.7 (39.9)Investment income 192.8 325.4 Valuation adjustments to financial assets (1,864.9) (132.8)Other operating income (expenses) (47.1) (31.5)Income (loss) before income taxes (1,660.5) 121.2 Income taxes 18.2 18.6 Income (loss) for the year (1,642.3) 139.8

The loss for the year 2006 amounts to Euros 1,642.3 million compared to income of Euros 139.8million in 2005.

• Financial income (expenses) compared to December 31, 2005 show an improvement of Euros 98.6million. Compared to the prior year, this improvement is due principally to higher gains from thesale of investments during 2006 (+Euros 136 million) and higher interest income earned on loansmade to Pirelli Tyres S.p.A. (+Euros 13 million) and was offset in part mostly by higher financial

96




expenses for the interest on loans made by Pirelli Finance (Luxembourg) SA (+Euros 18 million)and the price adjustment on the sale of the energy and telecommunications cables and systemsactivities on July 28, 2005 to Goldman Sachs Capital Partner (+Euros 30 million).

Details of “investment income” are as follows:


Subsidiaries:Pirelli Tyre Holding N.V. 100.0 120.0 Pirelli & C. Real Estate S.p.A. 40.7 36.4 Sipir Finance N.V. 7.0 147.0 Pirelli S.A. 1.9 2.8 Other minor companies - 0.6 Associates:Eurostazioni S.p.A. 1.6 1.3 Other companies:Consortium S.p.A. 11.2 -Mediobanca S.p.A. 8.7 6.8 Capitalia S.p.A. 9.9 3.4 Telecom Italia S.p.A. 6.6 5.2 RCS Mediagroup S.p.A. 3.9 0.9 Other minor companies 1.3 1.0 Total 192.8 325.4

The item “valuation adjustments to financial assets” increased significantly due to theimpairment loss on the investment in Olimpia S.p.A. (Euros 1,827 million).

The net expense balance of “other operating income (expenses)” increased as a result of the IPOcosts and the change/reduction in the services rendered following the sale of the cables activities onJuly 28, 2005.

97




98


Compensation paid to Directors, Statutory Auditors and General Managers (in thousands of euros)

Individual Description of post Compensation received in 2006 Compensationfor the year 2006 to be paid in 2007

Name Post Term Compensation Non- Bonuses Other Compens. Bonusesheld of office for the post monetary and other compens. for the and other

benefits incentives post incentivesTronchetti Provera Marco Chairman 2008 2,802 45 (2) 50 1,200Pirelli Alberto Deputy Chairman 2008 555 353 (3) 50 50 (3)

Puri Negri Carlo Alessandro Deputy Chairman 2008 315 2,085 (4) 50 3,668 (4)

Buora Carlo Managing Director up to 11/6/06 196 37 (5)

General Manager up to 11/6/06 6 14,811 (6)

Acutis Carlo Director 2008 50Angelici Carlo Director 2008 25 (7) 50Benetton Gilberto Director 2008 50Bombassei Alberto Director from 9/12/06 15Bruni Franco Director 2008 25 (7) 50De Benedetti Carlo (1) Director up to 5/5/06 17Galateri di Genola Gabriele (1) Director 2008 50Garraffo Mario Director 2008 50Giarda Dino Piero Director 2008 50Libonati Berardino Director 2008 20 (8) 50Ligresti Giulia Maria Director 2008 50Moratti Massimo Director 2008 50Perissinotto Giovanni Director 2008 50Pesenti Giampiero Director 2008 20 (8) 50Roveri Aldo Director 2008 20 (8) 50Secchi Carlo Director 2008 35 (9) 50Vagnone Paolo Director 2008 50De Conto Claudio General Manager - 4 586 653 350Gobbi Luciano General Manager - 3 544 607 350Gori Francesco General Manager up to 6/30/06 2 200 874(10) 480Guatri Luigi Chairman

of the Board of Statutory Auditors 2009 62Bracchetti Roberto Standing members up to 4/20/06 12 117(11)

Laghi Enrico Standing members from 4/21/07 29Lazzati Paolo Standing members 2009 107(12) 411) Remuneration paid over to his company2) As Chairman of Pirelli & C. Real Estate S.p.A.3) From Pirelli Tyre S.p.A.4) From Pirelli & C. Real Estate S.p.A. and its subsidiaries5) As a Director of Pirelli & C. Real Estate S.p.A.6) Of which Euros 13,423 thousand paid in addition to employees’ leaving indemnity due by law, at the same time as resigning from the posts of CEO and General Manager on November 6, 20067) As a member of the Internal Control and Corporate Governance Committee8) As a member of the Remuneration Committee9) As a member of the Internal Control and Corporate Governance Committee (Euros 25 thousand) and the Supervisory Board (Euros 10 thousand)10) Of which Euros 403 thousand from Pirelli & C. S.p.A. and Euros 471 thousand from Pirelli Tyre S.p.A.11) For the post of Chairman of the Board of Statutory Auditors of Pirelli & C. Real Estate S.p.A. (Euros 56 thousand) and of Pirelli & C. Ambiente S.p.A. (Euro 5 thousand), and the post of statutory Auditory in

subsidiaries of Pirelli & C. Real Estate S.p.A. (Euros 56 thousand)12) For the post of Chairman of the Board of Statutory Auditors of Pirelli Tyre S.p.A. (Euros 22 thousand), for the post of Statutory Auditor in subsidiaries of Pirelli & C. Real Estate S.p.A. (Euros 75 thousand)

and as a member of the Supervisory Board of Pirelli & C. S.p.A. (Euros 10 thousand)

Shareholders’ resolutions

Appropriation of result

The year ended December 31, 2006 shows a loss of Euros 1,642,304,515.The board proposes to absorb the loss by using the available reserves.

If in agreement with our proposal, we ask you to pass the following

RESOLUTION

The shareholders' meeting:

• having taken note of the Directors’ Report on Operations;

• having taken note of the reports of the board of statutory auditors’ and the independent auditors;

• having examined the financial statements at December 31, 2006 which show a loss of Euros 1,642,304,515

RESOLVES

a) to approve:- the Directors’ Report on Operations;- the balance sheet, the income statement, the notes to the financial statements for the year ended

December 31, 2006 which show a loss of Euros 1,642,304,515 as presented by the board ofdirectors in their entirety and in the individual entries, with the proposed accruals;

b) to completely absorb the loss for the year 2006 of Euros 1,642,304,515 as follows:

• by completely using the merger reserve Euros 583,707,610

• by completely using the contribution reserve Euros 22,391,115

• by completely using the monetary revaluation reserve Law 413/91 Euros 707,349

• by completely using the monetary revaluation reserve Law 72/83 Euros 972,216

• by completely using retained earnings Euros 286,057,304

• by partially using the share premium reserve Euros 748,468,921

taking note that the same share premium reserve, after the above utilization, is equal to Euros10,466,928.

99


IntroductionThe Group2006 operating andfinancialMajor events in 2006Group consolidationPirelli LabsSignificant eventssubsequent to the endof the yearOutlook for the currentyearReconciliation ofconsolidated equityProgrammatic securitydocumentsPirelli TyrePirelli BroadbandSolutionsPirelli & C. Real EstatePirelli & C. AmbienteInformation systemsProforma dataEquity Investments heldby Directors, StatutoryAuditors and GeneralManagersStock option plansCorporate GovernancePirelli & C. S.p.A. -Summary Data

A Shareholders’ Resolutions

Nomination of two directors and/or reduction in the number of themembers of the board of directors. Inherent and consequent resolutions.

Dear Shareholders,

The board of directors in its meeting held on September 12, 2006 passed a resolution appointingAlberto Bombassei as a director to replace Carlo De Benedetti who resigned at the beginning of May2006.

On the date of today’s shareholders’ meeting, the mandate conferred by the board of directors to Mr.Bombassei’s will expire.

Subsequently, on November 6, 2006, Carlo Buora tendered his resignation from all posts held inPirelli & C. S.p.A..

In this last case, also in view of the imminence of the shareholders’ meeting that was to be held forthe approval of the financial statements for the year ended December 31, 2006, the board did notmake a replacement so that the shareholders could indicate the candidates and/or propose a possiblereduction in the number of directors.

Having said this, the board of directors invites the shareholders’ meeting to take the necessarydecisions as a result of the two directors no longer being in office.

100




Amendment to the Regulations for Shareholders’ Meetings approved byresolution of the ordinary shareholders’ meeting held on May 11, 2004

Dear Shareholders,

In connection with the proposed amendments to the bylaws, which will be examined by you in thespecial session, you are called to review the updates to the Regulations for Shareholders’ Meetingsadopted by the shareholders’ meeting held on May 11, 2004.The most important changes refer to the effects on the organization of the work of the shareholders’meetings deriving from the introduction of the institution of the addition of matters to the agenda atthe request of shareholders in accordance with Law 262 dated December 28, 2005.In particular, the chairman of the meeting shall have the right to grant those shareholders who haverequested, under the law and the bylaws, the addition of matters to be discussed in the shareholders’meeting, a time of not more than 15 minutes to illustrate the corresponding motions on which topass resolutions and to explain the reasons thereto (new article 8).In giving the shareholders the possibility of proposing additions to the agenda, account is also takenof interventions proposed in the renumbered article 12, aimed at ensuring the proposing shareholdersthe same rights held by the board of directors to amend or add to their motions.On this occasion, it was also decided to propose some additional changes of a formal nature aimedat offering better clarity.Having said this, if you are in agreement with us, we ask you to approve the following

RESOLUTION

“The shareholders’ meeting:– having examined the report of the Board of Directors;– having considered the provision of article 2364, first paragraph, number 6) of the Italian Civil Code

and that of article 8 of the bylaws

RESOLVES

to change articles 3, 4, 5, 6, 7, 12, 13, 14 and 15 of the Regulations for Shareholders’ Meetings,approved by resolution of May 11, 2004 cited at the beginning and to introduce a new article 8, withthe following update of the numbering of the articles, in the terms resulting from the text reportedbelow with an indication of the amendments introduced:

101




EXISTING TEXT

PIRELLI & C. SOCIETA’ PER AZIONI

REGULATIONS FOR SHAREHOLDERS’ MEETINGS

Article 1- These Regulations shall apply to the

company’s ordinary and extraordinaryshareholders’ meetings.

Article 2- To ensure the regular conduct of shareholders’

meetings, for matters not expressly governedby these Regulations, the Chairman of themeeting (hereinafter the “Chairman”) shalladopt the measures and solutions deemedmost appropriate, in compliance with the lawand the bylaws.

Article 3- Meetings may be attended, with the right to

take part in the discussion and to vote, bypersons entitled to do so pursuant to theapplicable provisions (hereinafter the“Participants”).

- Unless stated otherwise in the noticeconvening the meeting, personal identificationand verification of the right to attend themeeting shall begin at the place where it is tobe held at least one hour before the time fixedfor it to start. When the Participants have beenidentified and their right to attend verified,under the supervision of the Chairman, theauxiliary staff provided by the Company shallissue badges that serve for control purposesand to exercise the right to vote.

- The Participants shall be able to follow thediscussion, take the floor during the discussionand exercise their right to vote, in thetechnical manner specified on each occasionby the Chairman.

- Participants who, after being admitted to themeeting, intend for any reason to leave thepremises where it is being held, must informthe auxiliary staff.

Article 4- Directors, senior executive and employees of

the Company and of Group companies mayattend the meetings, as may other personswhose presence is deemed useful in relation tothe matters to be discussed.

PROPOSED TEXT

PIRELLI & C. SOCIETA’ PER AZIONI

REGULATIONS FOR SHAREHOLDERS’ MEETINGS

Articolo 1- These Regulations shall apply to the

Company’s ordinary and extraordinaryshareholders’ meetings.

Article 2- To ensure the regular conduct of shareholders’

meetings, for matters not expressly governedby these Regulations, the Chairman of themeeting (hereinafter the “Chairman”) shalladopt the measures and solutions deemedmost appropriate, in compliance with the lawand the bylaws.

Article 3- Meetings may be attended, with the right to

take part in the discussion and to vote, bypersons entitled to do so pursuant to theapplicable provisions (hereinafter the“Participants”).

- Unless stated otherwise in the noticeconvening the meeting, personal identificationand verification of the right to attend themeeting shall begin at the place where it is tobe held at least one hour before the time fixedfor it to start. When the Participants have beenidentified and their right to attend verified,under the supervision of the Chairman, theauxiliary staff provided by the Company shallissue badges that serve for control purposesand to exercise the right to vote

- The Participants shall be able to follow thediscussion, take the floor during the discussionand exercise their right to vote, in thetechnical manner specified on each occasionby the Chairman.

- Participants who, after being admitted to themeeting, intend for any reason to leave thepremises where it is being held, must informthe auxiliary staff.

Article 4- Directors, senior executive and employees of

the Company and of Group companies mayattend the meetings, following also thecourse of actions decide by the Chairman,as may other persons whose presence is

102




- With the agreement of the Chairman, theproceedings may be followed by professionals,consultants, experts, financial analysts andsuitably qualified journalists, accredited for asingle meeting, in areas which couldspecifically be set aside for that purpose.

- Persons accredited to follow the proceedingsmust report for identification by theCompany’s appointees at the entrance of thepremises where the meeting is to be held andcollect a special badge to be exhibited uponrequest.

Article 5- In accordance with the law and the bylaws, it

is up to the Chairman to direct the meetingand ensure the best conditions for its orderlyand effective conduct.

- The Chairman may authorize the use of audio-visual recording and transmission equipment.

Article 6- The Chairman shall be assisted in the conduct

of the meeting and in the preparation of theminutes by a Secretary, where a Notary publicis not present. The Secretary or the Notarypublic may in turn arrange to be assisted bypersons of their trust.

- The Chairman, for the purposes of conductingthe voting procedures, shall be assisted byscrutineers; he may use auxiliary staff toprovide the necessary technical support and tomaintain order.

Article 7- When the quorum for duly constituting the

shareholders’ meeting is not reached, after anappropriate period of time the Participantsshall be informed of the fact and thediscussion of the matters on the agenda shallbe understood to be deferred until the nextcall of the meeting, if any.

- During a meeting the Chairman may, if hedeems it desirable and the majority of thecapital represented at the meeting does notobject, suspend the proceedings for up tothree hours.

103




deemed useful in relation to the matters to bediscussed.

- With the agreement of the Chairman andfollowing the course of action decided byhim, the proceedings may be followed byprofessionals, consultants, experts, financialanalysts and suitably qualified journalists,accredited for a single meeting, in areas whichcould specifically be set aside for that purpose.

- Persons accredited to follow the proceedingsmust report for identification by theCompany’s appointees at the entrance of thepremises where the meeting is to be held andcollect a special badge to be exhibited uponrequest.

Article 5- In accordance with the law and the bylaws, it

is up to the Chairman to direct the meetingand ensure the best conditions for its orderlyand effective conduct.

- The Chairman may authorize the use of audio-visual recording and transmission equipment.

Article 6- In the conduct of the meeting and in the

preparation of the minutes the Chairman shallbe assisted by a Secretary, in case a Notarypublic is not present. The Secretary or theNotary public may in turn arrange to beassisted by persons of their trust.

- For the purposes of conducting the votingprocedures, the Chairman shall be assisted byscrutineers; he may use auxiliary staff toprovide the necessary technical support and tomaintain order.

Article 7- When the quorum for duly constituting the

shareholders’ meeting is not reached, after anappropriate period of time the Participantsshall be informed of the fact and thediscussion of the matters on the agenda shallbe understood to be deferred until the nextcall of the meeting, if any.

- During a meeting the Chairman may, if hedeems it desirable and the majority of thecapital represented at the meeting does notobject, suspend the proceedings for up tothree hours.

Article 8- The Chairman shall establish the order in

which the items on the agenda are to bediscussed, which may differ from thatindicated in the notice convening the meeting.

- He may provide for several items to bediscussed together or for the discussion toproceed item by item.

- The Chairman and, at his invitation, personsattending the meeting pursuant to the Article4, paragraph 1, shall explain the items on theagenda.

Article 9- It is up to the Chairman to conduct and

moderate the discussion, ensure itscorrectness and prevent disturbances of theregular course of the meeting.

- The Chairman, taking account of the subjectmatter and importance of the individual itemson the agenda, may establish at the start of themeeting the time - not less than 15 minutes -available to each speaker.

- The Chairman shall call on Participants tocomply with the time limits for speakingestablished in advance and to keep to thematters stated in the agenda. In the event ofan overrun and/or an abuse, the Chairmanshall interrupt the speaker.

Article 10- Persons who intend to speak must apply to the

Chairman or the Secretary, indicating thesubject they will address. Such requests maybe submitted until the Chairman closes thediscussion on the subject to which they refer.

- Participants may ask to take the floor a secondtime during the same discussion, for not morethan five minutes, exclusively in response to

104




Article 8– Opening the proceeding of the meetings,

the Chairman shall summarize all theitems of the agenda.

– The Chairman can grant to shareholders’who have required to add items to theagenda, according to the By-Laws and tothe provisions of law, up to 15 minutesfor describing the proposed resolutions tobe taken and for explaining the reasonswhy they are proposed.

Article 9- The Chairman shall establish the order in

which the items on the agenda are to bediscussed, which may differ from thatindicated in the notice convening the meeting.

- He may provide for several items to bediscussed together or for the discussion toproceed item by item.

- The Chairman and, at his invitation, personsattending the meeting pursuant to the Article4, paragraph 1, shall explain the items on theagenda.

Article 10- It is up to the Chairman to conduct and

moderate the discussion, ensure itscorrectness and prevent disturbances of theregular course of the meeting.

- The Chairman, taking account of the subjectmatter and importance of the individual itemson the agenda, may establish at the start of themeeting the time - not less than 15 minutes -available to each speaker.

- The Chairman shall call on Participants tocomply with the time limits for speakingestablished in advance and to keep to thematters stated in the agenda. In the event ofan overrun and/or an abuse, the Chairmanshall interrupt the speaker.

Article 11- Persons who intend to speak must apply to the

Chairman or the Secretary, indicating thesubject they will address. Such requests maybe submitted until the Chairman closes thediscussion on the subject to which they refer.

- Participants may ask to take the floor a secondtime during the same discussion, for not morethan five minutes, exclusively in response to

other speakers or to declare how they intend tovote.

Article 12- The Board of Directors and the Participants

may put forward, giving reasons, proposals foralternative or amended resolutions withrespect to those originally put forward by theBoard of Directors or by the Shareholderswho have requested to add items to theagenda in accordance with the By-Lawsand with the provisions of law.

- The Chairman shall evaluate the compatibilityof such proposals in relation to the agenda ofthe meeting and to the applicableprovisions.

Article 13- The members of the Board of Directors and

the Board of Statutory Auditors may intervenein the discussion; at the invitation of theChairman, persons attending the meetingpursuant to the Article 4, paragraph 1, mayalso take the floor, inter alia to respond torequests for clarification.

Article 14- The Chairman shall take appropriate measures

to ensure the orderly conduct of voting andprovide for the voting on an item to be heldimmediately after the close of the discussionthereof or at the end of the discussion of all theitems on the agenda.

- The Chairman shall establish how each votingprocedure is to be conducted and theprocedures for identifying and counting thevotes cast and shall be responsible forascertaining the results.

Article 15- Upon completion of the counting of the votes

with the help of the scrutineers and theSecretary, the results of the voting shall beannounced.

105




other speakers or to declare how they intendto vote.

Article 11 - The Board of Directors and the Participants

may put forward, giving reasons, proposals foralternative or amended resolutions withrespect to those originally put forward by theBoard of Directors.

- The Chairman shall evaluate the compatibilityof such proposals in relation to the agenda ofthe meeting.

Article 12- The members of the Board of Directors and

the Board of Statutory Auditors may intervenein the discussion; at the invitation of theChairman, persons attending the meetingpursuant to the Article 4, paragraph 1, mayalso take the floor, inter alia to respond torequests for clarification.

Article 13- The Chairman shall take appropriate measures

to ensure the orderly conduct of voting andprovide for the voting on an item to be heldimmediately after the close of the discussionthereof or at the end of the discussion of allthe items on the agenda.

- The Chairman shall establish how each votingprocedure is to be conducted and theprocedures for identifying and counting thevotes cast and shall be responsible forascertaining the results.

Article 14- Upon completion of the voting and the

necessary counting of the votes with the helpof the scrutineers and the Secretary, theresults of the voting shall be announced.

The Board of DirectorsMilan, March 12, 2007

THE GROUP

Consolidated Financial Statements at December 31, 2006CONTENTS Page

Consolidated balance sheet 108Consolidated income statement 109Consolidated statement of recognized income and expense 110Consolidated statement of cash flows 111

Notes to the consolidated financial statements 1121. General information 1122. Basis of presentation 1123. Summary of significant accounting policies 1164. Financial risk management policy 1245. Estimates and assumptions 1256. Segment information 1267. Property, plant and equipment 1298. Intangible assets 1339. Investments properties 13410. Investments in associates and joint ventures 13511. Available-for-sale financial assets 13912. Deferred tax assets and liabilities 14013. Trade receivables 14214. Other receivables 14215. Tax receivables 14316. Inventories 14417. Securities held for trading 14418. Cash and cash equivalents 14419. Equity 14520. Stock option plans 14621. Tax payables 15422. Provisions for other liabilities and charges 15423. Employee benefit obligations 15424. Borrowings from banks and other financial institutions 15925. Trade payables 16126. Other payables 16227. Financial instruments 16228. Commitments and contingencies 16329. Revenues from sales and services 16430. Other income 16431. Personnel costs 16532. Amortization, depreciation and impairments 16533. Other expenses 16534. Financial income 16635. Financial expenses 16636. Dividends 16737. Valuation of financial assets 16738. Share of earnings (losses) of associates and joint ventures 16739. Income taxes 16840. Income (loss) from discontinued operations 16941. Earnings (loss) per share 16942. Dividends per share 17043. Hyperinflation 17044. Related party disclosures 17145. Subsequent events 17246. Other information 174

List of investments 176Independent Auditors’ report 186

(in thousands of euros)CONSOLIDATED BALANCE SHEET 12/31/2006 12/31/2005

of which of whichrelated parties related parties

ASSETS7 Property, plant and equipment 1,574,589 1,571,9728 Intangible assets 516,374 476,801

10 Investments in associates and joint ventures 3,825,928 4,542,90211 Available-for-sale financial assets 1,006,898 1,032,31712 Deferred tax assets 64,230 82,30014 Other receivables 705,828 334,211 538,798 262,250 15 Tax receivables 10,917 9,2149 Investment properties - 5,140

NON-CURRENT ASSETS 7,704,764 8,259,44416 Inventories 715,533 681,05613 Trade receivables 999,669 168,125 943,434 190,089 14 Other receivables 356,205 11,888 325,018 1,007 17 Securities held for trading 119,174 179,63618 Cash and cash equivalents 269,574 300,33115 Tax receivables 33,432 58,19527 Financial instruments 29,147 67,061

CURRENT ASSETS 2,522,734 2,554,731TOTAL ASSETS 10,227,498 10,814,175

EQUITY19.1 Attributable to the equity holders of the company: 3,879,591 5,204,859

Share capital 2,789,950 2,762,696Other reserves 1,971,026 2,010,712Retained earnings 286,057 104,035Income (loss) for the year (1,167,442) 327,416

19.2 Attributable to the minority interest: 806,966 408,947Reserves 688,351 337,413Income for the year 118,615 71,534TOTAL EQUITY 4,686,557 5,613,806LIABILITIES

24 Borrowings from banks and other financial institutions 1,377,426 1,550,51226 Other payables 156,886 61,76822 Provisions for other liabilities and charges 145,119 170,56112 Deferred tax liabilities 42,931 54,60623 Employee benefit obligations 415,850 510,80221 Tax payables 9,708 2,65027 Financial instruments 4,751 2,048

NON-CURRENT LIABILITIES 2,152,671 2,352,94724 Borrowings from banks and other financial institutions 1,562,262 242 600,36225 Trade payables 1,102,456 25,085 1,018,264 26,549 26 Other payables 512,896 3,440 838,315 271 22 Provisions for other liabilities and charges 116,525 53,99921 Tax payables 48,769 688 42,20827 Financial instruments 45,362 294,274

CURRENT LIABILITIES 3,388,270 2,847,422TOTAL EQUITY AND LIABILITIES 10,227,498 10,814,175

The captions relating to transactions with related parties are disclosed in Note 44.

108


(in thousands of euros)CONSOLIDATED INCOME STATEMENT 2006 2005


29 Revenues from sales and services 4,841,224 371,439 4,545,669 405,229 30 Other income 292,763 104,138 283,612 117,902

of which, nonrecurring events 21,116Change in inventories of work in process,semifinished and finished products 6,840 13,404Raw materials and consumables used (1,773,194) (1,640,352)

31 Personnel costs (1,075,771) (5,471) (1,029,880) (8,149)32 Amortization, depreciation and impairments (215,328) (215,704)33 Other expenses (1,683,944) (111,081) (1,612,591) (106,333)

of which, non-recurring events (13,200) (20,998)Increase in property, plant and equipment frominternal work 8,796 10,761OPERATING PROFIT 401,386 354,919

34 Financial income 897,377 17,258 248,310 13,156of which, nonrecurring events 631,600

35 Financial expenses (365,123) (32) (313,682) (81)36 Dividends 65,857 26,344 26,694 10,050 37 Valuation of financial assets (54,394) (90,069)38 Share of earnings (losses) of associates and joint ventures (1,836,081) 251,366

of which, nonrecurring events (2,110,000)INCOME (LOSS) BEFORE INCOME TAXES (890,978) 477,538

39 Income taxes (127,848) (128,484)INCOME (LOSS) FROM CONTINUING OPERATIONS (1,018,826) 349,054

40 Income (loss) from discontinued operations (30,000) 49,896INCOME (LOSS) FOR THE YEAR (1,048,826) 398,950Attributable to:equity holders of the company (1,167,441) 327,416minority interest 118,615 71,534

41 EARNINGS (LOSS) PER SHARE (euros per thousand of shares)basic earnings (loss) per sharecontinuing operations (212.87) 55.53discontinued operations (5.57) 10.08

(218.44) 65.61diluted earnings (loss) per sharecontinuing operations (212.87) 55.32discontinued operations (5.57) 10.04

(218.44) 65.36

The captions relating to transactions with related parties are disclosed in Note 44.

109


110


CONSOLIDATED STATEMENT OF RECOGNIZED INCOME AND EXPENSE(in thousands of euros)

2006 2005

Differences on translation of foreign currency financial statements (94,843) 248,956

Fair value adjustment of available-for-sale financial assets 23,870 106,028

Net actuarial gains (losses) on employee benefits 51,081 (69,123)

Fair value adjustment of derivatives designated as cash flow hedges 38,189 9,414

(Gains (losses) taken to income upon disposal of available-for-salefinancial assets, or impairments (126,796) -

Tax effect (6,935) 9,759

Income (expenses) recognized directly in equity (115,434) 305,034

Income (loss) for the year (1,048,826) 398,950

Total income (expenses) recognized directly in equity (1,164,260) 703,984

Attributable to:

- equity holders of the company (1,267,166) 626,682

- minority interest 102,906 77,302

(in thousands of euros)CONSOLIDATED STATEMENT OF CASH FLOWS 2006 2005


Income (loss) from continuing operations (1,018,826) 349,054Amortization, depreciation / impairment losses/reversals ofintangible assets and property, plant and equipment 212,691 212,678Financial expenses 365,123 313,682Financial income (897,377) (248,310)Dividends (65,857) (26,694)Valuation of financial assets 54,394 90,069Share of earnings (losses) of associates and joint ventures 1,921,699 (251,366)Change in inventories (34,477) (53,900)Change in trade receivables/payables 27,957 63,927Change in other receivables/payables (194,324) 31,415Change in employee benefit obligations/other provisions (29,608) (9,265)Other changes (8,131) (3,993)

A Net cash flows provided by (used for) operating activities 333,264 467,297Investments in property, plant and equipment (255,456) (233,624)Disposals of property, plant and equipment including gain/loss 11,906 8,750 Investments in intangible assets (54,884) (8,835)Disposals of intangible assets including gain/loss 192 852 Acquisitions of investments in associates and joint ventures (1,566,479) (1,405,257) (1,345,523)Disposals of investments in associates and joint ventures 1,315 2,599 Acquisitions of available-for-sale financial assets (251,386) (247,822) (15,320)Disposals of available-for-sale financial assets 374,516 13,500 16,629 Pirelli Tyre private placement 715,800 -Dividends received 65,857 26,694

B Net cash flows provided by (used for) investing activities (958,619) (1,840,014)Change in share capital and share premium reserve 27,254 1,065,634Other changes in equity (12,727) (16,820)Sale of Pirelli Real Estate shares 84,400 -Change in financial payables 926,396 212,441 Change in financial receivables (18,768) (265,396)Financial income/expenses(net of gains on fin. assets avail.-for-sale) (99,346) (65,372)Effect of sale of Cables and Systems - 490,000Dividends paid (162,672) (29,089) (149,542) (29,762)

C Net cash flows provided by (used for)financing activities 744,537 1,270,945

D Total cash flows from discontinued operations - (258,629)

E Total cash flows provided by (used) during the year (A+B+C+D) 119,182 (360,401)

F Cash and cash equivalents, at beginning of the year 146,310 490,005

G Exchange differences on translation of cashand cash equivalents (6,103) 16,706

H Cash and cash equivalents, at end of the year (E+F+G) (°) 259,389 146,310

(°) of which:cash 269,574 300,331bank overdrafts (10,185) (154,021)

The consolidated statement of cash flows shows transactions with related parties that cannot be directly deduced from theother statements.

111


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

1. GENERAL INFORMATION

Pirelli & C. S.p.A. is a corporation organized under the laws of the Republic of Italy.

Founded in 1872 and listed on the Milan Stock Exchange, Pirelli & C. S.p.A. is a holding companywhich manages, coordinates and finances the operations of its subsidiaries.

At the balance sheet date, the company’s businesses are mainly represented by investments in:

• Pirelli & C. Real Estate S.p.A. - a listed company operating in the real estate sector – 50.3 percentof share capital;

• Pirelli Tyre S.p.A. - a company operating in the tyres sector – 61.1 percent of share capital;• Pirelli Broadband Solutions S.p.A. - a company operating in the field of components, equipment and

systems for telecommunications – 100 percent of share capital;• Olimpia S.p.A. – a company which holds 18 percent of the share capital of Telecom Italia S.p.A.

represented by ordinary shares (18.92 percent of voting rights under IFRS as described in note 10)– 80 percent of share capital;

• Pirelli & C. Ambiente S.p.A. – a company operating in the environmental services sector – 51percent of share capital.

The registered office of the company is in Milan, Italy.

The consolidated financial statements are audited by PricewaterhouseCoopers S.p.A. pursuant to art.159 of Legislative Decree 58 dated February 24, 1998 and taking into account the Consobrecommendation dated February 20, 1997, in execution of the resolution passed by the shareholderson April 28, 2005 which engaged the audit firm for the three years 2005-2007. The fees agreed for theaudit of the consolidated financial statements for the year 2006 amount to Euros 2,889 thousand,inclusive of the fees relating to the limited review of the interim consolidated financial statements atJune 30, 2006.

2. BASIS OF PRESENTATION

Accounting policies adopted

In accordance with Regulation 1606 issued by the European Parliament and by the Council of theEuropean Union in July 2002, the consolidated financial statements of the Pirelli & C. Group havebeen prepared in accordance with the International Financial Reporting Standard (IAS/IFRS)effective at December 31, 2006.The accounting policies adopted for the preparation of the consolidated financial statements atDecember 31, 2006 have not changed since December 31, 2005 except for the comments below inrespect of the measurement of investment properties.For purposes of a better accounting representation and a more appropriate presentation of thetransactions for a more meaningful understanding of the financial statements and comparability withmajor domestic and international operators, starting from these financial statements for the yearended December 31, 2006, as permitted by IAS 40, the Group has decided to measure investmentproperty at fair value instead of cost, net of the relative depreciation and impairment losses. Thistreatment has not resulted in any change to retained earnings since the value of investment propertyin the financial statements at December 31, 2005 approximated fair value. The effect on the result forthe year 2006 in respect of the investment property held through associates has resulted in income ofEuros 11 million.

112


Moreover, the company has applied Consob resolution 15519 dated July 27, 2006 with regard tofinancial statement formats and Consob communication 6064293 dated July 28, 2006 with regard todisclosures.

Reclassifications made to the prior year’s figures presented for comparison purposes with the figuresat December 31, 2006 are reported in the following table:

(in thousands of euros)Published 2005 comparatives in Reclassifications

12/31/2005 financial statements12/31/2006

Deferred tax assets 77,046 82,300 5,254 Other non-current receivables 529,393 538,798 9,405 Non-current tax receivables 18,619 9,214 (9,405)Other current receivables 272,252 325,018 52,766 Current tax receivables 110,961 58,195 (52,766)TOTAL RECLASSIFICATIONS ASSETS 1,008,271 1,013,525 5,254

Deferred tax liabilities (49,352) (54,606) (5,254)Non-current provisions for other liabilitiesand charges (144,734) (170,561) (25,827)Current provisions for other liabilities and charges (79,826) (53,999) 25,827 Other non-current payables (53,196) (61,768) (8,572)Non-current tax payables (8,706) (2,650) 6,056 Other current payables (771,538) (838,315) (66,777)Current tax payables (111,501) (42,208) 69,293 TOTAL RECLASSIFICATIONS LIABILITIES (1,218,853) (1,224,107) (5,254)

In addition, the lines “Investments in associates” and Investments in joint ventures” have beencombined into one line “Investments in associates and joint ventures”.

Accounting standards or interpretations not yet effective or not yet endorsed by theEuropean Union

As required by IAS 8 “Accounting Policies, Changes in Accounting Estimates and Errors”, newStandards and new Interpretations not yet effective or not yet endorsed by the European Union aresummarized and briefly described below.None of these Standards or Interpretations has been early applied by the Group.

New standards or interpretations which are effective but are not yet endorsed by the EuropeanUnion

• IFRIC 10 – Interim Financial Reporting and ImpairmentThis interpretation deals with the interaction between the requirements of IAS 34 (Interim FinancialReporting) and the impairment of goodwill (IAS 36 – Impairment of Assets) and certain financialassets (IAS 39 – Financial instruments: Recognition and Measurement). IFRIC 10 states that werean entity has recognized an impairment loss in an interim period on goodwill or on investment in anequity instrument, that impairment cannot be reversed in subsequent interim financial statementsnor in the annual financial statements.The interpretation is effective from January 1st, 2007 but has not yet been approved by theEuropean Union.

New standards or interpretations not yet effective but already endorsed by the European Union

• IFRS 7 – Financial Instruments: DisclosuresThis standard, endorsed by the European Union in January 2006 (EC Regulation 108-2006),

113


supersedes IAS 30 (Disclosures in the Financial Statements of Banks and Similar FinancialInstitutions) and includes the section on disclosures contained in IAS 32 (Financial Instruments:Presentation and disclosure) with amendments and additions the title of IAS 32 has been changedto “Financial Instruments: Presentation”.IFRS 7 is effective starting from January 1st, 2007.

• Amendments to IAS 1 – Presentation of Financial Statements – Capital DisclosuresThese amendments, endorsed by the European Union in January 2006 (Regulation EC 108-2006),provide that an entity presents disclosures that allow users of the financial statements to evaluateits objectives, policies and procedures for managing capital.These amendments are effective from January 1st, 2007.

• IFRIC 7 – Applying the Restatement Approach under IAS 29, Financial Reporting inHyperinflationary EconomiesThis interpretation, endorsed by the European Union in May 2006 (EC Regulation 708/2006),provides guidance on how to apply the requirements of IAS 29 in a reporting period in which anentity for the first time identifies the existence of hyperinflation in the economy of its functionalcurrency. Under IFRIC 7, the entity should restate the amounts in its financial statements inaccordance with IAS 29, as if the economy had always been hyperinflationary.IFRIC 7 is effective starting from January 1st, 2007.

• IFRIC 8 – Scope of IFRS 2IFRIC 8, endorsed by the European Union in September 2006 (EC Regulation 1329/2006), clarifiesthat IFRS 2 also applies to arrangements where an entity makes share-based payments for servicesfor apparently nil or inadeguate consideration.In particular, IFRIC 8 states that where the identifiable consideration given appears to be lowerthan the fair value of the equity instrument granted (or liability incurred), this typically indicatesthat additional consideration has been or will be received.IFRIC 8 is effective starting from January 1st, 2007.

• IFRIC 9 – Reassessment of Embedded DerivativesThis interpretation, endorsed by the European Union in September 2006 (EC Regulation1329/2006), requires an entity to assess whether an embedded derivative is required to beseparated from the host contract and accounted for as a derivative when the entity firstbecomes a party to the contract, that is, at the time of initial recognition. Subsequentreassessment is prohibited unless there is a change in the terms of the contract that significantlymodifies the original cash flows.IFRIC 9 is effective starting from January 1st, 2007.

New standards or interpretations not yet effective and not yet endorsed by the European Union

• IFRIC 11 – IFRS 2 – Group and Treasury Share TransactionsIFRIC 11 provides guidance on applying IFRS 2 (Share-based Payment) to certain types of plansinvolving different units of the Group.IFRIC 11 applies starting from January 1st, 2008.

• IFRIC 12 – Service Concession ArrangementsIFRIC 12 deals with service concession arrangements with private operators for the supply ofpublic services such as roads, airports, energy and water distribution. Under these arrangements,the assets are not necessarily controlled by the private operators which, however, are responsiblefor constructing, operating or maintaining the public sector asset.The assets, under the arrangements, could possibly not be recorded as property, plant and

114


equipment in the financial statements of the private operators but rather as financial assets and/orintangible assets depending on the type of service concession arrangement.IFRIC 12 applies starting from January 1st, 2008.

• IFRS 8 – Operating SegmentsThis standard supersedes IAS 14 (Segment Reporting) and aligns segment disclosures with therequirements of US GAAP (SFAS 131 Disclosures about Segments of an Enterprise and RelatedInformation), introducing the approach whereby the segments are identified in the same way theyare identified in internal reports for management.IFRS 8 will be effective starting from January 1st, 2009.

At the present time, the future application of the above standards and interpretations is not expectedto have a significant quantitative impact on the consolidated financial statements of Pirelli & C. Group.

Financial statement formats

The format adopted for the balance sheet distinguishes the assets and liabilities between current andnon-current.The income statement is prepared under the costs by nature format.The format for the changes in equity is entitled “Statement of recognized income and expense” andincludes the result for the year and, by homogeneous categories, the income and expenses which,under IFRS, are recognized directly in equity. The amounts of transactions with shareholders andmovements during the year in reserves are presented in the explanatory notes.In the statement of cash flows, cash flows from operating activities are presented using the indirectmethod where the income or loss for the year is adjusted by the effect of non-monetary transactions,by any deferral or accrual of previous or future operating collections or payments and by revenues orcosts connected with cash flows from investing or financing activities.

Scope of consolidation

The scope of consolidation includes the subsidiaries, the associates and the investments in jointventures.Subsidiaries are considered all those companies and entities in which the Group has the power todetermine the financial and operating policies. This circumstance is generally considered to occurwhen more than half of the voting rights are held.Joint ventures are considered those companies in which, under a contractual agreement or inaccordance with the bylaws, two or more parties undertake an economic activity subject to jointcontrol as defined in IAS 31.Associates are considered all those companies in which the Group exercises a significant influence.This influence is presumed to exist when the Group holds a percentage of voting rights between 20and 50 percent.

Consolidation

For consolidation purposes, the financial statements used are those of the companies included in thescope of consolidation, prepared at the closing date and adjusted, where necessary, to conform toIAS/IFRS as applied by the Group.The financial statements expressed in foreign currencies are translated into euros at rates prevailingat the year-end for the balance sheet and at the average exchange rates for the income statement.

115


The differences arising from the translation of opening net equity at year-end exchange rates havebeen recognized in the reserve for translation differences, together with the difference between theresult in the income statement, translated at average rates, and result included in the balance sheet,translated at year-end rates. The reserve for translation differences is recognized in the incomestatement when the company that generated the reserve is either sold or put into a wind-up.The consolidation principles can be summarized as follows:• Subsidiaries are consolidated on a line-by-line basis according to which:

– the assets and liabilities and revenues and costs of the financial statements of the subsidiariesare assumed in full, regardless of the percentage of ownership;

– the carrying amount of the investments is eliminated against the corresponding share of net equity;– the balance sheet and income statement transactions between companies consolidated line-by-

line, including dividends distributed within the Group, are eliminated;– the equity or income (loss) attributable to the minority interest is presented separately in equity

and in the income statement;• investments in associates and joint ventures are accounted for by the equity method and the

carrying amount of the investments is adjusted by:– the share of the post-acquisition results of the associate or joint venture;– the adjustments from movements in equity that were not recognized in the income statement in

accordance with benchmark principles;– dividends paid by the investment holding;

• gains on transactions for sales made by subsidiaries to joint ventures and associates are eliminatedto the extent of the Group’s interest in the joint ventures and associates;

• gains arising on transactions for sales of properties made by one joint venture to other jointventures or associates are recognized to the extent of the lower of the Group’s interest in the buyercompany compared to that of the seller company, that is, only to the extent of the gain realizedwith third parties;

• gains arising on sales transactions of properties from associates to other associates are recognizedto the extent of the gain realized with third parties;

• at the time of acquisition of the subsidiary, associate or joint venture, the price paid is allocatedaccording to the purchase method by: – determining the cost of acquisition in accordance with IFRS 3;– determining the fair value of the assets and liabilities acquired (both actual and contingent);– by allocating the price paid to the fair value of the assets acquired and liabilities assumed;– by recognizing any residual amount in goodwill, consisting of the excess of the cost of

acquisition over the net fair value of the Group’s share of the identifiable assets, liabilities andcontingent liabilities;

– by immediately recognizing the negative goodwill, if any, directly in the income statement if thefair value of the net assets acquired exceeds the cost of acquisition.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Intangible assets

Intangible assets with a definite useful life are measured at cost less accumulated amortization andaccumulated impairment losses.

Amortization starts when the asset is available for use.

GoodwillGoodwill is subjected to impairment testing at least on annual bases.Goodwill is allocated to cash-generating units for purposes of impairment testing.

116


Trademarks and licensesTrademarks and licenses are stated at cost less accumulated amortization and accumulatedimpairment losses. Cost is amortized over the duration of the contract or the asset’s estimated usefullife, wichever is shorter.

SoftwareSoftware license costs, including direct incidental costs, are capitalized and recorded in the balancesheet less accumulated amortization and accumulated impairment losses.

Research and developmentResearch expenditures for new products and/or processes are expensed when incurred.There are no development costs which meet the conditions for capitalization.

The useful lives of intangible assets are the following:Trademarks and licenses 5 yearsSoftware not more than 3 years

Property, plant and equipment

Property, plant and equipment are measured at the cost of acquisition or production and includedirectly attributable incidental expenses.Property, plant and equipment are stated at cost less accumulated depreciation and accumulatedimpairment losses, except for land, which is not depreciated and is stated at cost less accumulatedimpairment losses.Depreciation is accounted starting from the month in which the asset is available for use, or ispotentially able to provide the economic benefits associated with it.Depreciation is calculated monthly using the straight-line method at rates designed to write-off theassets to the end of their residual useful lives or, for disposals, until the last month of use.Depreciation rates are as follows:

Buildings 3% - 10%Plant 7% - 10%Machinery 5% - 10%Equipment 10% - 33%Furniture 10% - 33%Motor vehicles 10% - 25%

Government grants relating to property, plant and equipment are recognized as deferred income andcredited to the income statement over the period of depreciation of the relative assets.Borrowing costs incurred for the purchase of an asset are expensed unless they are directlyattributable to the purchase, construction or production of a qualifying asset, in which case they arecapitalized.Leasehold improvements are classified as property, plant and equipment, consistently with the natureof the costs incurred. The depreciation period corresponds to the remaining useful life of the asset orthe residual period of the lease contract, whichever is sooner.Major spare parts are capitalized and depreciated over the estimated useful life of the assets towhich they refer.Assets acquired under finance lease contracts are accounted for as property, plant and equipmentwith a contra-entry to the related financial liability. The lease payment is split between interestexpense, recorded in the income statement, and the repayment of principal, recorded as a reductionof the financial liability.

117


Investment property

Investment property is defined as property held to earn rent and or for capital appreciation.

Investment property is initially recognized at cost, including transaction costs, and subsequentlymeasured at fair value. The changes in the fair value of investment property are recorded in theincome statement.

The fair value of an investment property reflects the market value at the balance sheet date andrepresents the amount at which the investment property could be exchanged between knowledgeableand willing parties in an arm’s length transaction and after the outcome of adequate salesnegotiations based on the principle of reciprocal independence.

Each single property is measured and takes into consideration the future rental income and, wheresignificant, the relative costs, discounted by applying a discount rate that reflects the risks specific tothe cash flows generated by the asset.

The income or expense representing changes in the fair value of the investment property is recordedin the income statement in the year in which the change occurs.

The gain or loss on the disposal of investment property is calculated as the difference between thenet proceeds and the accounting amount of the asset and is recorded in the income statement in theyear of disposal.

When there is a change in use of an investment property from inventories to investment property tobe recognized at fair value, the difference between the fair value at the balance sheet date and theprevious carrying amount is recorded in the income statement.

When there is a change in use from investment property recognized at fair value to owner-occupiedproperty, the fair value at the date of the change of use is considered the cost of the property underits new classification.

Impairment of assets

Property, plant and equipment and intangible assetsWhenever specific indicators point to an impairment loss, the property, plant and equipment and theintangible assets are tested for impairment.The test consists of an estimate of the recoverable amount of the asset and a comparison with itscarrying amount.The recoverable amount of an asset is the higher of its fair value less costs to sell and its value inuse, where value in use is the present value of estimated future cash flows originating from the useof the asset and those deriving from its disposal at the end of its useful life.If the recoverable amount is lower than the asset’s carrying amount, the carrying amount is reducedto the recoverable amount. This reduction constitutes an impairment loss which is recognized in theincome statement.For intangible assets with an indefinite life, including goodwill, the impairment test is performedannually, regardless of the presence of specific indicators.

Investments in associates and joint venturesFor impairment test purpose, the value of investments in associates and joint ventures accounted forby the equity method must be compared with the recoverable amount. The recoverable amount

118


corresponds to the higher of the fair value, less costs to sell, and the value in use. It is not necessaryto estimate both amounts since it is sufficient to verify that one of the two amounts is higher thanthe accounting amount in order to establish the absence of an impairment.In keeping with recent interpretations, for purposes of impairment testing, the fair value of aninvestment in an associate or joint venture with shares listed on an active market is always equal toits market value regardless of the percentage of ownership.In order to determine the value in use of an associate or joint venture accounted for by the equitymethod, the following estimates should be made:

a) the share of the present value of estimated future cash flows that will be generated by theassociate or joint venture, including cash flows generated by the operating activities of theassociate or joint venture and the consideration that will be received on the final disposal of theinvestment (known as the Discounted Cash Flow – asset side)

b) the present value of estimated future cash flows that will be generated by dividends to be receivedand the final disposal of the investment (known as the Dividend Discount model – equity side).

Available-for-sale financial assets

Available-for-sale financial assets include investments in other companies and other securities notheld for trading. They are included in non-current assets since there is no intention to dispose ofthem within 12 months of the balance sheet date.For measurement purposes, they are classified as available-for-sale financial assets and measured atfair value. Fair value gains and losses are recognized in a specific reserve in equity.

In case of impairment losses or in the event of disposal, the gains and losses recognized up to thattime in equity are reversed to the income statement.Any impairment losses recognized on available-for-sale financial assets in the income statementcannot be reversed through the income statement.Purchases and sales of available-for sale financial assets are recognized on the settlement date.

Inventories

Inventories are stated at the lower of cost, using the FIFO method, and the estimated realizablevalue.

Construction contracts

A construction contract is a contract specifically negotiated for the construction of an asset based onthe instructions of a principal that, as a preliminary step, designs the plans and the technicalcharacteristics.Contract revenues include the consideration initially agreed, in addition to changes in theconstruction work and price variations envisaged by the contract that can be determined reliably.When the outcome of a construction contract can be estimated reliably, they are measured using thepercentage of completion method. The stage of completion is measured by reference to the costsincurred up to the balance sheet date as a percentage of total estimated costs for each contract.Contract revenues are compared to contract costs incurred to reach the stage of completion.Costs incurred during the year in connection with future contract activity are excluded from contractcosts in determining the stage of completion and recorded as inventories.When it is probable that total contract costs will exceed total contract revenue, the expected loss isrecognized as an expense immediately.

119


The gross amount due from customers for contract work for all the contracts in progress and forwhich the costs incurred plus recognized profit (less recognized losses) exceed progress billings isincluded in trade receivables.The gross amount due to customers for contract work for all contracts in progress for whichprogress billings exceed costs incurred plus recognized profit (less recognized losses) is included intrade payables.

Receivables and payables

Receivables and payables are initially recorded at their fair value, generally represented by thepresent value of the amount that will be collected or paid.Subsequently, they are measured at amortized cost, and in the case of receivables, less bad debtprovision.Junior notes generated by transactions for the securitization of non-performing loans (NPL) as wellas non-performing deep discount receivables included in non-current assets and current assets, areclassified as loans and receivables and measured at amortized cost, less bad debt provision.The amortized cost is calculated using the effective interest rate method. The effective interest rate isequivalent to the rate used to discount future cash flows to arrive at exactly the net carrying amountat the initial recognition date.Any impairment of junior securities is represented by the difference between the projections of theestimated future net cash flows on the underlying non-performing loan portfolios at the date ofacquisition of the notes, and the projections of the estimated future net cash flows of these sameportfolios, updated to the date of the preparation of the financial statements, both discounted at theeffective interest rate determined at the date of the acquisition of the junior securities. When theconditions that gave rise to the impairment of the junior notes no longer exist, the impairment lossesrecorded in previous periods are cancelled by a credit to the income statement up to the amortizedcost which would have been recorded had no impairment loss been recognized.The accounting amount of non-performing loans is adjusted whenever there is a change in thepresent value of the estimated future cash flows. Any differences are recognized in the incomestatement.Receivables and payables in currencies other than the functional currency of the individualcompanies are adjusted to the year-end exchange rates with a contra-entry to the income statement.Receivables are derecognized when the right to receive cash flows from the receivables have expiredor the Group has transferred substantially all the risks and rewards of ownership or the receivable isconsidered definitively irrecoverable after all the necessary recovery procedures have beencompletedPayables are derecognized when the specific contractual obligation is extinguished.

Securities held for tradingSecurities held for trading include securities principally purchased for resale in the short term. Suchsecurities are classified as current assets.Securities held for trading are measured at fair value through the income statement. Transactioncosts are expensed in the income statement.Purchases and sales of financial assets held for trading are recognized on the settlement date.

Cash and cash equivalents

Cash and cash equivalents include bank and postal deposits and cash on hand. Cash and cashequivalents are stated at nominal value.

120


Provisions for other liabilities and charges

Provisions for other liabilities and charges include accruals for current obligations (legal orconstructive) deriving from a past event, for the fulfillment of which an outflow of resources willprobably be necessary, the amount of which can be estimated in a reliable manner.

Employee benefits

Employee benefits paid subsequent to the termination of the employment relationship classified aspost-retirement benefits under defined benefit plans and other long-term benefits are subject toactuarial calculations. The liability recorded in the financial statements is the present value of theGroup’s obligation, net of plan assets, if any.With regard to employee benefits, the Pirelli & C. Group elected the option allowed by IAS 19 underwhich actuarial gains and losses are recognized in the statement of recognized income and expensein the year in which they arise.For other long-term benefits, the actuarial gains and losses are recognized directly in the incomestatement.The interest cost and the expected return on plan assets are classified in personnel costs.

Stock option

Stock options are divided into two types which require different accounting treatments according tothe features of the plan:• equity-settled: are plans in which the grantee has the right to purchase shares of the company

at a fixed price whenever specific conditions are met. In such cases, the fair value of the option,determined at the grant date, is recognized as an expense over the period of the plan with acontra-entry to increase the reserves in equity;

• cash-settled: are plans which provide for put options on behalf of the grantee, combined with calloptions on behalf of the issuer, or plans in which the grantee directly receives the monetaryequivalent amount of the benefit originating from the exercise of the stock option. The fair value ofthe liability, re-measured at the end of every reporting period, is recognized in the incomestatement over the vesting period. The changes in the fair value of the liability subsequent to thevesting period are recognized in the income statement.

Financial instruments

Derivatives are recognized initially at fair value with a contra-entry to the income statement.They are subsequently re-measured at fair value; fair value gains or losses are recognized in theincome statement except for interest rate swaps designated as cash flow hedges.

Derivatives that qualify as cash flow hedgesIn all cases in which derivatives are designated as hedging instruments for purposes of IAS 39, theGroup documents at the inception of the transaction the relationship between hedging instrumentsand hedged items, as well as its risk management objective and strategy for undertaking varioushedge transactions.The Group also documents its assessment, both at hedge inception and on an ongoing basis, ofwhether the derivatives that are used in hedging transactions are highly effective in offsettingchanges in the cash flows of hedged items.The effective portion of changes in the fair value of derivatives that are designated and qualify ascash flow hedges are recognized directly in equity. The gain or loss relating to the ineffective portionis recognized immediately in the income statement.Amounts recognized directly in equity are reversed to the income statement in the periods when thehedged item produces an effect in the income statement.

121


When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedgeaccounting, any cumulative gain or loss existing in equity at that time remains in equity and isrecognized when the hedged item ultimately produces an effect in the income statement.When the hedged item is no longer expected to produce an effect in the income statement, thecumulative gain or loss that was reported in equity is immediately transferred to the incomestatement.

Derivatives that do not qualify for hedge accountingChanges in the fair value of any derivative instruments that do not qualify for hedge accounting arerecognized immediately in the income statement.

Fair value estimationThe fair value of financial instruments traded in active markets is based on listed market prices atthe balance sheet date. The listed market price used for financial assets is the current bid price; theappropriate listed market price for financial liabilities is the current ask price. The fair value offinancial instruments that are not traded on an active market is determined by using valuationtechniques with a variety of methods and assumptions that are based on market conditions existingat each balance sheet date.The fair value of interest-rate swaps is calculated as the present value of estimated future cash flows.The fair value of forward foreign exchange contracts is determined using the forward rate at thebalance sheet date.

Income taxes

Current income taxes are determined on the basis of a realistic estimate of the tax expense payableunder the current tax laws of the country.Deferred taxes are calculated on temporary differences arising between the asset and liabilityamounts in the balance sheet and their tax bases (full liability method). They are classified in non-current assets and liabilities.Deferred tax assets are only recognized when there is a probability of future recovery.

Equity

Treasury sharesTreasury shares are classified as a deduction from equity.In the event of sale, re-issue or cancellation, the gains and losses as a result thereof are classified inequity.

Costs of equity transactionsCosts directly attributable to equity transactions of the parent are recognized as a deduction fromequity.

Recognition of revenues

Revenues are measured at the fair value of the consideration received for the sale of the products orservices.

Sales of productsRevenues from sales of products are recognized when all the following conditions are met:• the significant risks and the rewards of ownership of the goods are transferred to the buyer;• the effective control over the goods has ceased;• the amount of revenues is determined in a reliable manner;• it is probable that the economic benefits deriving from the sale will flow to the group;• the costs incurred or to be incurred are determined in a reliable manner.

122


With specific reference to sales of properties, revenues are generally recognized at the time whenownership has been transferred to the buyer which corresponds to the date of the deed of sale. If thenature and measure of the involvement of the seller are such as to cause that the risks and rewardsof ownership are not in fact transferred, then the recognition date of the revenues is deferred untilsuch time as the transfer can be considered to have taken place.

Rendering of servicesRevenues from rendering of services are recognized by reference to their completion at the balancesheet date.With regard specifically to the revenues from the rendering of services of Telecom Italia S.p.A. (anassociate of the joint venture Olimpia S.p.A whose share of the results is included in the consolidatedfinancial statements by the equity method), the revenues for activating telephone services (as well asthe relative costs) are deferred over the estimated duration of the relationship with the customer.Revenues from prepaid traffic are recorded on the basis of the minutes used at the contract price perminute. The revenues from the income of recharging prepaid cards and the relative costs with thelatter not exceeding the amount of the income from recharging cards, are deferred over the periodbetween two subsequent recharges (about one month). Starting from the year 2006, following theintroduction of new types of contracts which bind the customer to Telecom Italia for periods of 24months, otherwise a penalty is applied, the Company capitalizes directly attributable subscriberacquisition costs to intangible assets and recognizes them in the income statement over the period ofthe underlying contract. In all other cases, subscriber acquisition costs are expensed when incurred.

Dividend incomeDividend income is recognized when the right to receive payment is established, which normallycorresponds to the resolution passed by the shareholders’ meeting for the distribution of dividends.Dividends received from associates and joint ventures are recognized as a deduction from thecarrying amount of the investment.

Segment information

The business segment (primary reporting segment) is a distinctly identifiable part of the Group whichsupplies a single product or service or an aggregate of related products and services and is subject torisks and rewards different from those of the other business segments of the Group.The geographical segment (secondary reporting segment) is a distinctly identifiable part of the Groupwhich supplies a single product or service or an aggregate of related products and services and issubject to risks and rewards different from those relating to the components which operate in othereconomic environments.

Accounting principles for hyperinflationary countries

The Group companies that operate in high-inflation countries have to restate the amounts in theiroriginal respective financial statements in order to eliminate distorting effects due to the loss of thepurchasing power of the currency. The inflation rate used to adopt inflation accounting correspondsto the consumer price index.The companies adopt inflation accounting in countries where cumulative inflation rate over athree-year period approximates or exceeds 100 percent and discontinue it in the event whencumulative inflation rate over a three-year period falls below 100 percent.Gains and losses on monetary positions are recognized in the income statement.

Classification of property portfolio: inventories (IAS 2) – Investment property (IAS 40)

In accordance with the business model prevalent within the Group, the majority of property assetsare classified in inventories insofar as they are held for the purpose of trading and are in any caseintended for sale during the course of the normal operating cycle of the companies included in thescope of consolidation.

123


4. FINANCIAL RISK MANAGEMENT POLICY

Financial risk management is an integral part of the management of the Group’s operations. Riskmanagement is carried out centrally using policies defined by the General Finance and StrategicPlanning Department and approved by the chief executive officer. Such policies define the categoriesof risk and specify the procedures and operating limits for each type of transaction and/orinstrument. In accordance with these policies, the Group uses derivative contracts in relation tounderlying financial assets or liabilities or future transactions. Financial risk management iscentralized at the Sector Treasury Units which have the task of evaluating the risks and putting intoplace the relative hedges under the coordination of Group Treasury. The Sector Treasury Units actdirectly in the market on behalf of the Operating Units and, where they cannot operate directlybecause of external restrictions, they coordinate the activities with the Local Treasury Unit.

Type of risk covered

Foreign exchange riskThe Group operates internationally and is exposed to foreign exchange risk, managed by the SectorTreasury Units and coordinated by Group Treasury.The Operating Units are responsible for gathering all the information inherent to the positionssubject to foreign exchange risk which are managed by forward contracts negotiated with the SectorTreasury Units.The Sector Treasury Units are responsible for evaluating and managing the net position for everycurrency, consistent with policies and restrictions, by negotiating derivative contracts on the market,generally forward contracts.Forward contracts between the Operating Units and the Sector Treasury Units as well as thoseamong the Sector Treasury Units and the market are not designated as hedging instruments asdefined by IAS 39 although they are in place for the purposes of managing risks.

Credit riskThe Group has no significant concentrations of credit risk. The policies in place ensure a properevaluation of the financial soundness of the customers.

Liquidity riskPrudent liquidity risk management implies maintaining sufficient cash and/or short-term securitiesthat can be readily converted into cash, the availability of funding through an adequate amount ofcommitted credit facilities and/or the ability to close out market positions. Due to the dynamicnature of the businesses in which it operates, the Group aims to maintain flexibility in funding bykeeping committed credit lines available.

Interest rate riskThe Group’s interest-rate risk arises from long-term borrowings. Borrowings issued at floating ratesexpose the Group to cash flow risk. Borrowings issued at fixed rates expose the Group to fair value.Group policy is to maintain approximately 70 percent of its long-term borrowings in fixed rateinstruments.The Group manages its cash flow interest-rate risk also by using derivative contracts, generallyfloating-to-fixed interest-rate swaps.The designation of such derivatives as hedging instruments under IAS 39 is decided case by case andauthorized centrally by the General Finance and Strategic Planning Department and the GeneralOperations Department.

124


5. ESTIMATES AND ASSUMPTIONS

The preparation of the consolidated financial statements requires management to make estimates andassumptions which, in some circumstances, are based on difficult and subjective judgments andestimates derived from historical experience and assumptions which are believed to be reasonableand realistic under the circumstances. Such estimates affect the reported amounts of some assetsand liabilities, costs and revenues, as well as the disclosure of contingent assets and liabilities at thebalance sheet date.The estimates and assumptions will generally refer to the measurement of the recoverable amountsof intangible assets, the definition of the useful lives of property, plant and equipment, therecoverability of receivables and the recognition and measurement of provisions. The estimates andassumptions are based upon data which reflects the current state of available knowledge.

Accounting policies of particular importance requiring a higher degree of judgmentThe accounting policies involving a higher degree of judgment by management in making estimatesand for which a change in the conditions underlying the assumptions could have a significantimpact on the consolidated financial statements are the following:

a. Investment in the Olimpia joint venture- Although the interest held in Olimpia S.p.A. (80 percent) is higher than 50 percent, the investment

qualifies as a joint venture by virtue of the bylaws and the shareholders’ agreements. In particular,Pirelli, even though it has the absolute majority of voting rights (80 percent), may not appoint morethan three out of the six directors (art. 13 of the bylaws). Furthermore, art. 17 of the same bylawsstate that the resolutions of the Board shall only be valid if the majority of the directors in officeare present and the resolutions are passed by majority vote.Finally, art. 12 of the bylaws establishes that the special shareholders’ meeting is duly constitutedand the resolutions are passed by a favorable vote cast by as many shareholders as thoserepresenting at least 81 percent of the share capital. This quorum also applies to the validity of theresolutions that change or eliminate the clause for the slate to nominate directors as well as thevariation in the number of the members of the board of directors.

- In the impairment test of Olimpia S.p.A., the estimates and assumptions made by managementmainly refer to the estimate of the value in use of the investment in Telecom Italia S.p.A., for whichthe following factors were incorporated:

a) flows of results (operating) and dividends as well as the discount and capitalization rates usedby the analysts (aligned with the consensus) who follow Telecom Italia stock;

b) multiples of comparable transactions, for the estimate of the final amount under the asset sidecriterion;

c) premiums paid in transactions involving listed companies operating in the telecommunicationssector in both Europe and the United States (the country where the sector concentrationprocess first began) to estimate the consideration on the disposal of the shares under the equityside criterion.

In the impairment test on the investment in Olimpia, valuation techniques commonly applied byexperts in company valuations were used, taking into accound the information available at the dateof the preparation of the financial statements. Given the complexity of the valuation and thesignificance of the amount of the investment, the estimates resulting could vary as a result ofchanges in the assumptions and the hypotheses used for the impairment test.

b. GoodwillIn accordance with the accounting policies applied in the preparation of the financial statements,goodwill is tested annually in order to assess whether there is an impairment that should be recordedin the income statement. In particular, the test involves the allocation of goodwill to cash-generatingunits and the determination of the relative recoverable amount, understood as being the higher offair value and the value in use.If the value in use is lower than the accounting amount of the cash-generating units, an impairment

125


on the goodwill allocated to them should be recognized. The allocation of goodwill to cash-generating units and the determination of their value in use involves estimates which depend onsubjective valuations as well as on factors which could change over time with consequent andpossibly significant effects on the assessment made by management.

c. Impairment of property, plant and equipment and intangible assetsIn accordance with the accounting policies applied, property, plant and equipment and intangibleassets are tested to ascertain if there is an impairment, which should be recognized, when there areindications that would imply difficulties in recovering the net carrying amount through the use of theasset. The verification of the existence of these indications requires management to make judgmentsbased on available internal or external information and historical experience. Moreover, when it hasbeen determined that there could be a potential impairment, that impairment must be determined byreference to suitable valuation techniques. The proper identification of elements indicating theexistence of a potential impairment and the estimates used to determine it depend on subjectivejudgments and factors which can vary over time and influence the assessments and estimates madeby management.

d. Deferred income taxesThe recognition of deferred tax assets is made on the basis of expectations of future income. Themeasurement of future income for purposes of recognizing deferred income taxes depends on factorswhich can vary over time and determine significant effects on the measurement of deferred taxassets.

e. Provisions for other liabilities and chargesAccruals are made for legal and fiscal liabilities and charges that will probably require an outflow ofresources. The amount of the provisions recorded in the financial statements relating to suchliabilities and charges represents the best estimate at that time made by management. This estimateinvolves assumption which depend on factors which can change over time and which could thereforehave significant effects on the current estimates made by management in the preparation of theconsolidated financial statements.

6. SEGMENT INFORMATION

For the Pirelli & C. Group, the business segment constitutes the primary segment whereas thegeographical segment represents the secondary segment.

a) primary reporting format – business segments

At December 31, 2006, continuing operations of the Group are divided into five main businesssegments:- Tyres (Pirelli Tyre)- Broadband- Environment- Real Estate (Pirelli & C. Real Estate)- Olimpia investment

The remaining part comprises financial companies (including the parent) and other servicecompanies. None of these constitutes a reportable segment.

Segment results of continuing operations for the year ended December 31, 2006 are as follows:

126


CONTINUING OPERATIONS (in thousands of euros)Tyre Broadband Environment Real Estate Olimpia Other TOTAL

- 2006Sales to third parties 3,947,159 129,434 66,261 691,161 - 7,209 4,841,224Sales to the Group 2,343 - 2,706 10,803 - (15,852) -TOTAL SALES 3,949,502 129,434 68,967 701,964 - (8,643) 4,841,224GROSS OPERATING PROFIT 533,653 1,056 480 113,089 - (34,201) 614,077Depreciation of property,plant and equipment (185,852) (1,299) (531) (5,773) - (7,973) (201,428)Amortization of intangible assets (5,457) (24) (173) (3,598) - (2,011) (11,263) OPERATING PROFIT (LOSS) 342,344 (267) (224) 103,718 - (44,185) 401,386Share of earnings (losses) of companiesaccounted for by the equity method 179 101,570 (1,940,039) 2,209 (1,836,081)Financial income (expenses) 532,254Dividends 65,857Valuation of financial assets (54,394)LOSS BEFORE INCOME TAXES (890,978) Income taxes (127,848)LOSS FOR THE YEAR (1,018,826)

Segment results of continuing operations for the year ended December 31, 2005 are as follows:

CONTINUING OPERATIONS (in thousands of euros)Tyre Broadband Environment Real Estate Olimpia Other TOTAL

2005Sales to third parties 3,632,667 112,155 59,907 690,330 - 50,610 4,545,669Sales to the Group 256 19 1,562 9,850 - (11,687) -TOTAL SALES 3,632,923 112,174 61,469 700,180 - 38,923 4,545,669GROSS OPERATING PROFIT 518,060 (6,330) (2,034) 92,844 - (34,943) 567,597Depreciation of property,plant and equipment (181,816) (644) (582) (5,224) - (8,772) (197,038)Amortization of intangible assets (7,462) (51) (1,007) (3,743) - (3,377) (15,640)OPERATING PROFIT (LOSS) 328,782 (7,025) (3,623) 83,877 - (47,092) 354,919Share of earnings (losses) of companiesaccounted for by the equity method 14 98,787 152,486 79 251,366Financial income (expenses) (65,372)Dividends 26,694Valuation of financial assets (90,069)INCOME BEFORE INCOME TAXES 477,538Income taxes (128,484)INCOME FOR THE YEAR 349,054

The method of measuring sales among sectors is the same as that applied for sales to third parties.

Segment assets, liabilities and capital expenditures at December 31, 2006 are as follows:

(in thousands of euros)Tyre Broadband Environment Real Estate Olimpia Other TOTAL

2006Segment assets 3,066,993 44,985 32,477 891,516 - 56,279 4,092,250Investments in associatesand joint ventures 1,010 - 660 285,798 3,487,855 53,528 3,828,851Unallocated assets 2,306,397TOTAL ASSETS 3,068,003 44,985 33,137 1,177,314 3,487,855 109,807 10,227,498Segment liabilities 1,484,001 55,459 17,029 453,060 - 345,032 2,354,581Unallocated liabilities 3,186,360TOTAL LIABILITIES 1,484,001 55,459 17,029 453,060 - 345,032 5,540,941Capital expenditures- property,plant and equipment 224,200 6,942 1,015 12,458 - 10,841 255,456Capital expenditures - intangibleassets 4,133 95 400 47,045 - 3,211 54,884

127


Segment assets, liabilities and capital expenditures at December 31, 2005 are as follows:

(in thousands of euros)Tyre Broadband Environment Real Estate Olimpia Other TOTAL

2005Segment assets 3,064,576 39,172 32,395 723,544 110,161 3,969,848 Investments in associatesand joint ventures 3,992 - 642 239,200 4,247,944 51,124 4,542,902 Unallocated assets 2,301,425 TOTAL ASSETS 3,068,568 39,172 33,037 962,744 4,247,944 161,285 10,814,175 Segment liabilities 1,538,913 56,947 16,304 452,598 745,697 2,810,459 Unallocated liabilities 2,389,910 TOTAL LIABILITIES 1,538,913 56,947 16,304 452,598 - 745,697 5,200,369 Capital expenditures- property,plant and equipment 208,326 3,377 510 7,932 13,479 233,624Capital expenditures - intangibleassets 4,004 242 531 3,108 950 8,835

Segment assets mainly consist of property, plant and equipment, intangible assets, assets underfinance leases, inventories, trade receivables and other receivables and exclude financial receivables,available-for-sale financial assets, securities held for trading and current and deferred tax assets.

Segment liabilities mainly include trade payables and other payables, advances from customers,provisions for other liabilities and charges and employee benefit obligations and exclude financialpayables and current and deferred tax liabilities.

Capital expenditures mainly refer to the purchase of plant and machinery.

b) secondary reporting format – geographical segments

Sales by geographical area, allocated on the basis of the country in which the customer resides, areas follows.

(in thousands of euros)Geographical areas 2006 2005Europe:- Italy 1,331,865 27.51% 1,382,769 30.42%- Other European countries 1,586,865 32.78% 1,494,600 32.89%North America 318,846 6.59% 286,600 6.30%Central and South America 1,029,302 21.26% 921,600 20.27%Oceania, Africa and Asia 574,346 11.86% 460,100 10.12%

4,841,224 100.00% 4,545,669 100.00%

Assets by geographical area, allocated on the basis of the country in which the assets are located, areas follows.

(in thousands of euros)12/31/2006 12/31/2005

AssetsEurope - Italy 6,941,147 8,124,512 - Other European countries 1,700,580 1,533,719 North America 136,721 142,698 Central and South America 950,625 621,373 Oceania, Africa and Asia 498,425 391,873

10,227,498 10,814,175

Capital expenditures by geographical area, allocated on the basis of the country in which the assetsare located, are as follows:

128


(in thousands of euros)2006 2005

Capital expendituresEurope- Italy 45,599 60,508 - Other European countries 149,344 76,682 North America 2,228 5,158 Central and South America 81,636 87,315 Oceania, Africa and Asia 31,533 12,796

310,340 242,459

7. PROPERTY, PLANT AND EQUIPMENT

At December 31, 2006, the composition and movements in property, plant and equipment are asfollows:


Gross carrying Accumul. Net carrying Gross car. Accumul. Net car.amount Depreciat. amount amount Deprec. amount

Land and improvements 83,186 - 83,186 67,272 - 67,272Buildings 636,276 (279,337 356,939 616,589 (274,890) 341,699Plant and machinery 2,453,970 (1,502,184) 951,786 2,421,571 (1,449,690) 971,881Industrial and comm. equipment 530,971 (405,094) 125,877 509,673 (387,135) 122,538Other property, plant and equipment 238,999 (182,198) 56,801 249,667 (181,085) 68,582

3,943,402 (2,368,813) 1,574,589 3,864,772 (2,292,800) 1,571,972

(in thousands of euros)Movements in gross carrying amount

12/31/2005 Exchange diff. Increase Decrease Reclass. Other 12/31/2006Land and improvements 67,272 (2,236) 3,613 (1,397) 5,748 10,186 83,186Buildings 616,589 (12,567) 34,044 (17,124) 10,849 4,485 636,276Plant and machinery 2,421,571 (79,890) 160,988 (22,156) (28,707) 2,164 2,453,970Industrial and comm. equipment 509,673 (16,549) 37,879 (16,823) 13,827 2,964 530,971Other property, plant and equipment 249,667 (4,556) 18,932 (22,420) (1,717) (907) 238,999

3,864,772 (115,798) 255,456 (79,920) - 18,892 3,943,402

(in thousands of euros)Movements in accumulated depreciation

12/31/2005 Exchange Reclass. Decrease Deprec./ Other 12/31/2006difference impairments

Buildings (274,890) 5,553 831 14,572 (23,551) (1,852) (279,337)Plant and machinery (1,449,690) 49,617 844 18,219 (120,361) (813) (1,502,184)Industrial and comm. equipment (387,135) 13,238 (441) 13,576 (42,234) (2,098) (405,094)Other property, plant and equipment (181,085) 3,405 (1,234) 11,646 (16,427) 1,497 (182,198)

(2,292,800) 71,813 - 58,013 (202,573) (3,266) (2,368,813)

(in thousands of euros)Movements in net carrying amount

12/31/2005 Exchange Incr. Decr. Reclass. Deprec./ Other 12/31/2006differences impairments

Land and improvements 67,272 (2,236) 3,613 (1,397) 5,748 - 10,186 83,186Buildings 341,699 (7,014) 34,044 (2,552) 11,680 (23,551) 2,633 356,939Plant and machinery 971,881 (30,273) 160,988 (3,937) (27,863) (120,361) 1,351 951,786Industrial and comm. equipment 122,538 (3,311) 37,879 (3,247) 13,386 (42,234) 866 125,877Other property, plant and equipment 68,582 (1,151) 18,932 (10,774) (2,951) (16,427) 590 56,801

1,571,972 (43,985) 255,456 (21,907) - (202,573) 15,626 1,574,589

129


At December 31, 2005, movements were as follows:(in thousands of euros)

Movements in gross carrying amount12/31/2004 Discont. Change in Exchan. Increase Decr. Reclass. Other 12/31/2005

operations scope of differen.consolid.

Land and improvements 127,834 (64,014) 2,178 2,118 (3,410) 964 1,602 67,272Buildings 983,891 (445,107) 30,813 49,800 (15,335) 1,553 10,974 616,589Plant and machinery 3,550,203 (1,538,035) 72,333 178,380 120,706 (29,836) 11,631 56,189 2,421,571Industrial and comm.equipment 524,285 (96,449) 27,134 34,460 (9,392) 14,976 14,659 509,673Other property,plant and equipment 490,477 (221,919) 13,870 26,540 (14,696) (29,124) (15,481) 249,667Total 5,676,690 (2,365,524) 72,333 252,375 233,624 (72,669) - 67,943 3,864,772

(in thousands of euros)Movements in accumulated depreciation

12/31/2004 Discont. Change inExchan. Reclass. Decr. Deprec./ Other 12/31/2005operations scope of differen. impair.

consolid.Buildings (452,466) 214,915 (15,547) 138 5,828 (21,490) (6,268) (274,890)Plant and machinery (2,441,975) 1,202,630 (75,253) 1,192 20,173 (119,617) (36,841) (1,449,691)Industrial and comm.equipment (404,222) 83,559 (19,709) (3) 5,022 (40,891) (10,890) (387,134)Other property,plant and equipment (297,180) 129,342 (7,018) (1,327) 12,076 (18,066) 1,088 (181,085)

(3,595,843) 1,630,446 - (117,528) - 43,099 (200,064) (52,911) (2,292,800)

(in thousands of euros)Movements in net carrying amount

12/31/2004 Discont. Change in Exchan. Increase Decr. Reclass. Deprec./ Other 12/31/2005operations scope of differen. impair.

consolid.Land andimprovements 127,834 (64,014) 2,178 2,118 (3,410) 964 - 1,602 67,272Buildings 531,425 (230,192) 15,266 49,800 (9,507) 1,691 (21,490) 4,706 341,699Plant andmachinery 1,108,228 (335,405) 72,333 103,127 120,706 (9,663) 12,823 (119,617) 19,348 971,880Industrial and comm. equip. 120,063 (12,890) 7,425 34,460 (4,370) 14,973 (40,891) 3,769 122,539Other property,plant and equip.193,297 (92,577) 6,852 26,540 (2,620) (30,451) (18,066) (14,393) 68,582

2,080,847 (735,078) 72,333 134,848 233,624 (29,570) - (200,064) 15,032 1,571,972

Increases in the year 2006 mainly refer to the new operating units of the Tyres Sector in Romania(at Slatina), in China (at Yanzhou) and the build-up of the production facilities in Brazil with a viewtowards increasing production capacity, especially at Bahia and Gravatai.The ratio of additions during the year to depreciation is 1.27.Assets under construction at December 31, 2006 amount to Euros 69,512 thousand (Euros 58,892thousand at December 31, 2005).Impairments in 2006, included in the column “Depreciation and impairments” in the above table,amount to Euros 2,638 thousand (Euros 3,026 thousand at December 31, 2005) and are recorded inthe income statement under “Amortization, depreciation and impairments” (Note 32).Restrictions on the ownership of assets are as follow:– machinery and plant for Euros 14,076 thousand are used as collateral to secure a loan from the

National Bank of Egypt obtained by the subsidiary Alexandria Tyre Company S.A.E. (Euros 16,985thousand at December 31, 2005);

– machinery and land for Euros 77,645 thousand are used as collateral by the subsidiary Pirelli PneusS.A. (Euros 76,411 thousand at December 31, 2005).

Borrowing costs have not been capitalized to property, plant and equipment.

130


7.1. LEASING

Buildings, plant, machinery and other assets purchased by the Group under finance leases areincluded in the respective categories of property, plant and equipment.

Details are as follows:


Capitalized Accumulated Net carry. Capitalized Accumulated Net carry. cost depreciation amount cost depreciation amount

Land leased 11,187 - 11,187 11,187 - 11,187Buildings leased 64,415 (10,992) 53,423 64,591 (18,711) 45,880Other property, plant andequipment leased 1,036 (631) 405 10,796 (341) 10,455Plant and machinery leased 1,828 (631) 1,197 146 (146) -

78,466 (12,254) 66,212 86,720 (19,198) 67,522

Details of the most important contracts regarding buildings leased are as follows:

Italy:

• Pirelli & C. S.p.A. has a leasing contract with a syndicate of banks (DEUTSCHE BANK LEASINGS.p.A. - now SG LEASING S.p.A. - Franfinance Leasing Italia; SOGELEASE ITALIA S.p.A. – now SGLEASING S.p.A. - Franfinance Leasing Italia; LOCAT S.p.A.) on the building which houses thestructures and the R&D activities of the Tyres Sector.The contract, signed in May 2000, has a term of 13 years and a purchase option at expiration.This contract was sold during 2006 by the subsidiary Pirelli Tyre S.p.A. (ex-Pirelli PneumaticiS.p.A.) to Pirelli & C. S.p.A..The net book amount of the building is equal to Euros 43,563 thousand (Euros 45,221 thousand atDecember 31, 2005).

Germany:

• the subsidiary Pirelli Deutschland GmbH has a leasing contract with the company DAL-Florenta onthe distribution warehouse located in Breuberg. The term of the contract is divided into twoperiods: the first period has a term of 15 years from January 1, 1995 to December 31, 2009; thesecond period has a term of another 7.5 years. The contract has a purchase option;

• the subsidiary Pneumobil GmbH has five leasing contracts with the company DAL on the buildingsof five points of sale in Germany. The terms of the contracts are between 20 and 25 years. All thecontracts expire between 2008 and 2010. The contracts have purchase options.The net carrying amount of the buildings total Euros 7,715 thousand (Euros 9,183 thousand atDecember 31, 2005).

Finance lease payables associated with the above significant contracts are included in financialpayables (Note 24).

131


Minimum lease payments due (that is, the payments requested by the lessor over the remaining leaseperiod) are detailed as follows:

(in thousands of euros)12/31/2006

Germany Italy Totaldue within 1 year 1,091 4,151 5,242due between 1 and 5 years 7,923 16,603 24,526due beyond 5 years - 16,643 16,643Total 9,014 37,397 46,411Future financial expenses (1,024) (7,529) (8,553)Leases payable 7,990 29,868 37,858Altri contratti 1,365Total in financial statements (Note 24) 39,223

The minimum lease payments due at December 31, 2005 were as follows:


Germany Italy Totaldue within 1 year 1,181 5,189 6,370 due between 1 and 5 years 9,642 16,603 26,245 due beyond 5 years - 20,794 20,794 Total 10,823 42,586 53,409 Future financial expenses (2,099) (9,717) (11,816)Leases payable 8,724 32,869 41,593 Other contracts 60Total in financial statements (Note 24) 41,653

The following table shows finance lease payables associated with the above significant contractsdivided by expiration date:


Germany Italy Totaldue within 1 year 721 2,554 3,275due between 1 and 5 years 7,269 11,737 19,006due beyond 5 years - 15,577 15,577Total 7,990 29,868 37,858Other contracts 1,365Total in financial statements (Note 24) 39,223

At December 31 2005, the breakdown by expiration date was as follows:


Germany Italy Totaldue within 1 year 607 3,001 3,608due between 1 and 5 years 8,117 11,111 19,228 due beyond 5 years - 18,757 18,757 Total 8,724 32,869 41,593 Other contracts 60Total in financial statements (Note 24) 41,653

132


8. INTANGIBLE ASSETS

The composition and movements in intangible assets are as follows:

(in thousands of euros)12/31/2005 Exch. Increase Decr. Amortiz./ Other 12/31/2006

differen. impairm.Patents and intellectual property rights 992 - 21 - (263) 27 777Concessions, licenses and trademarks 21,330 - 5,145 (65) (2,215) (7) 24,188Goodwill 440,568 (111) 42,201 - - (2,924) 479,734Software 12,437 (17) 4,888 (18) (8,480) 1,307 10,117Other intangible assets 1,474 (35) 2,629 (110) (1,798) (602) 1,558

476,801 (163) 54,884 (193) (12,756) (2,199) 516,374

(in thousands of euros)12/31/2004 Discont. Exch. Increase Decr. Amortiz./ Other 12/31/2005

operations differen. impairm.Patents and intellectual property rights 2,294 (42) - 113 (96) (1,274) (3) 992Concessions, licensesand trademarks 21,819 (104) - 1,653 (104) (2,010) 76 21,330Goodwill 460,028 (15,262) 118 - - - (4,316) 440,568Software 24,742 (5,526) 151 5,569 - (12,057) (442) 12,437Other intangible assets 3,995 (3,137) 42 1,500 (618) (299) (9) 1,474

512,878 (24,071) 311 8,835 (818) (15,640) (4,694) 476,801

The increase in 2006 in “Goodwill” includes Euros 40,561 thousand relating to the followingtransactions in the real estate segment (Pirelli & C. Real Estate Group):

• for Euros 1,606 thousand, the purchase of the entire investment in Aponeo S.r.l. on July 27, 2006, acompany later merged by Pirelli & C. Real Estate Facility Management S.p.A.;

• for Euros 5,161 thousand, the purchase of the remaining 52.63 percent stake of Pirelli RE CreditServicing S.p.A. (ex-Credit Servicing S.p.A.) on November 30, 2006; this company evaluatesmortgage loan portfolios and manages the credit recovery process both in court and in out-of-courtsettlements;

• for Euros 26,771 thousand, the purchase of shares from the minority shareholder of Pirelli & C.Real Estate Società di Gestione del Risparmio S.p.A. held as a result of the sale option exercised bythe latter on June 27, 2006. The price was established on the basis of a global valuation of thecompany, equal to approximately Euros 315 million, made by Credit Suisse;

• for Euros 3,062 thousand, the purchase of the shares of P&K Real Estate GmbH from theshareholder Kronberg Partecipazioni Immobiliari S.r.l.;

• for Euros 3,257 thousand, the purchase on April 3, 2006 from Bank Pekao S.A. of 75 percent ofPekao Development Sp.zo.o., now Pirelli Pekao Real Estate Sp.zo.o., one of the major real estateoperators on the Polish market employing about 40 staff and managing several residentialdevelopment projects mainly in the city of Warsaw.

Goodwill under IAS 36 is not amortized but it is subject to impairment test at least annually. Forpurposes of assessing impairment, goodwill is allocated to the cash-generating units or groups ofcash-generating units, considering the highest level of aggregation that may not exceed the businesssegment identified in accordance with IAS 14.

133


At December 31, 2006, the breakdown of goodwill according to the business segments and the cash-generating units to which it was allocated for purposes of assessing impairment are shown in thefollowing table:

(in thousands of euros)Business segment Cash-generating unit AmountTyres Consumer 208,522Tyres Industrial 172,956Environment Eco Technologies 4,860Real Estate Services 57,220Real Estate Franchising network 425Real Estate Investment & Asset Management 35,751

479,734

The test consists of estimating the recoverable amount of the cash-generating unit and comparing itwith the net carrying amount of the relative assets including goodwill.The recoverable amount of the cash-generating unit has been determined on the basis of the value inuse, that is, the present value of future cash flows which is estimated to be associated with the cash-generating unit.Cash flows used to determine the value in use are based on projections covering a five-year periodand are based on:- for the Real Estate Sector, for the first three years, on projections approved by management; the

cash flows for the fourth and fifth year correspond to the cash flows for the last year of the planwhile the cash flows generated by the disposal of the cash-generating units at the end of the explicitperiod correspond to the perpetual return again based on the last year of the plan;

- for the Tyres Sector, for the first year, on plans approved by management; the cash flows relating tothe second to the fifth year and the cash flows generated by the disposal of the cash-generatingunits at the end of the explicit period (assumed as being equal to the present value of the perpetualreturn of cash flows generated in the last year of projection) have been extrapolated using a growthfactor of about 2 percent to the cash flows of the first year.

At December 31, 2006, the discount rates, net of taxes, applied to the cash flow projections are asfollows:

Business segment Cash-generating unit Discount rateTyres Consumer 7.20%Tyres Industrial 7.20%Environment Eco Technologies 7.80%Real Estate Services 7.31%Real Estate Franchising network 7.31%Real Estate Investment & Asset Management 7.31%

On the basis of the results of the tests performed, no impairment arose.

9. INVESTMENTS PROPERTIES

Investments properties at December 31, 2005 referred to a former industrial structure denominated“Hangar Bicocca” then held by Lambda S.r.l..After the building was sold to Pirelli & C. Real Estate S.p.A. and its use changed, the building wasreclassified to property, plant and equipment under land and buildings.

134


10. INVESTMENTS IN ASSOCIATES AND JOINT VENTURES

Investments in associates and joint ventures total Euros 3,825,928 thousand compared to Euros4,542,902 thousand at December 31, 2005.

Movements during the year are as follows:


Beginning amount 4,542,902 2,984,387Discontinued operations - (18,492)Adoption of IAS - (964)Acquisition/change in share capital and reserves 1,228,115 1,411,869Distribution of dividends (87,188) (130,729)Disposals and wind-ups (50,972) (1,317)Share of earnings (1,836,411) 251,272Reclassifications (1,206) -Other 30,688 46,876

3,825,928 4,542,902

The following table details the movements in investments in associates:

(in thousands of euros)12/31/2005 Acquisitions/ Distribut. Disposals Share of Reclas. Other 12/31/2006

change in share of and earnings capital and dividends/ wind-ups (losses)

reserves/other reservesDixia S.r.l. 5,822 16 - - (249) - - 5,589Orione Immobiliare Prima S.p.A. 12,946 - (11,435) - 201 - - 1,712Sci Roev Texas Partners L.P. 2,125 - (308) - 407 - - 2,224Spazio Investment N.V. - 25,200 - - 624 (250) 21,990 47,564Turismo e Immobiliare S.p.A. 4,061 912 - - (826) - - 4,147Stip Tunisi 1,206 - - - - (1,206) - -SMP Melfi S.r.l. 1,807 - - (1,807) - - -Eurostazioni S.p.A. 53,861 - (1,570) - 2,249 - (924) 53,616Other 1,107 359 (1,656) - (176) - 23 (343) Total investmentsin associates 82,935 26,487 (14,969) (1,807) 2,230 (1,456) 21,089 114,509

Note that the fair value at December 31, 2006 of the company Spazio Investment N.V., listed on theAlternative Investment Market of the London Stock Exchange, is equal to Euros 52.3 million, whichwas calculated using the market price at December 29, 2006 of Euros 14.95.

The following table details the movements in investments in joint ventures:



reserves/other reservesAfrodite S.à r.l. 923 (60) - - 2,980 - - 3,843Alceo B.V. 621 495 - - (1,420) - 304 -Alimede Luxembourg S.à.r.l. - 129 - - (75) - - 54Alnitak S.à r.l, - 1,844 - - 262 - - 2,106Altair Zander Italia S.r.l. 61 - - - 9 - - 70Aree Urbane S.r.l. 8,167 18 - - (265) - - 7,920Artemide S.à r.l. 714 (78) - - 1,781 - - 2,417

135




reserves/other reservesAustin S.à.r.l. - 1,445 - - 5,051 (2,706) - 3,790Bernini Immobiliare S.r.l. 1,323 (570) (472) - (281) - - -Capitol Immobiliare S.r.l. 3 165 - - (129) - - 39Castello S.r.l. 44 - - - 100 - - 144Colombo S.a.r.l. 1,346 1,113 - - 3,071 - - 5,530Consorzio ARP - 53 - - - - 53Consorzio G6 Advisor 22 - - - - - - 22Continuum S.r.l. 6,226 - (2,702) - 1,164 - - 4,688Dallas S.à.r.l. - 1,445 - - 5,051 (2,706) - 3,790Dolcetto Otto S.r.l. - 18 - - (7) - - 11Domogest S.r.l. 908 - - - 117 - - 1,025Doria S.a.r.l. 1,357 1,002 - - 3,063 - - 5,422Elle Dieci S.c.a.r.l. 40 - - - - - - 40Elle Tre S.c.a.r.l. 40 - - - - - - 40Erice S.r.l. 1,053 - - - 198 - - 1,251Espelha - Serviços de Consultadoria Lda. - 35,177 - - 4,045 - - 39,222European NPL S.A. - 9,166 - - 30 - - 9,196Fattoria Medicea S.r.l. - 549 - - (24) - - 525Galatea S.r.l. - 348 - - (384) - 36 -Geolidro S.r.l. 10,497 (10,330) - - (167) - - -Gestioni Immobiliari 2003 S.r.l. - 105 - - (7) - - 98Golfo Aranci S.p.A. - Società di trasformazione urbana - 1,378 - - - - 1,378Immobiliare Prizia S.r.l. 4,178 (19) - - 2,192 - - 6,351IN Holdings I S.a.r.l. 2,184 - (1,640) - (137) - - 407Induxia S.r.l. 2,307 - - - (501) - - 1,806Inimm Due S.a.r.l. 2,192 - - - 1,767 - - 3,959Iniziative Immobiliari S.r.l. 14,188 - (8,409) - 1,606 - - 7,385Localto S.p.A. 615 536 - (1,300) 149 - - -Localto ReoCo S.r.l. - 4 - - - - - 4LSF Italian Finance Company S.r.l. 5 - - (5) - - - -Maro S.r.l. (già M.S.M.C. Immobiliare Tre S.r.l.) - 53 - - (11) - - 42Masaccio S.r.l. - 196 - - (1) - - 195Masseto I B.V. 23,163 - (23,107) - 17,433 979 - 18,468Max B.V. 692 (2) - - 4,444 - - 5,134M.S.M.C. Italy Holding B.V. 17,533 88 (11,239) - 6,145 - - 12,527Mirandia – Trading e Consultoria LdA 41,607 - - (44,244) 2,637 - - -MP Facility S.r.l. 2,062 210 (890) - (145) - - 1,237MSPRE Luxembourg NPL S.à r.l. (in liquidation) 898 (979) - - 81 - - -Nashville S.à.r.l. - 1,445 - - 5,051 (2,705) - 3,791Pirelli RE Credit Servicing S.p.A. (ex-Credit Servicing S.p.A.) 9,001 (5,023) (1,895) - (2,083) - - -Polish Investemts Real Estate Holding B.V. - 2,475 - (11) (48) - - 2,416Progetto Bicocca La Piazza S.r.l. 557 - - - (185) - - 372Progetto Nuovo Sant'Anna S.r.l. - 1,479 - - (21) - - 1,458Popoy Holding B.V. 15,489 - (12,223) - 5,604 7,138 - 16,008Progetto Gioberti S.r.l. 42 - - - 316 - - 358Quadrifoglio Milano S.p.A. 5,509 81 - - (216) - - 5,374Resi S.r.l. (ex-Dolcetto Cinque S.r.l.) - 5 - - 3 - - 8Resident Berlin P&K 1 GmbH - 7,665 (3,932) - 122 - - 3,855

136




reserves/other reservesRinascente/Upim S.r.l. 9,819 (427) - - (4,747) - - 4,645Riva dei Ronchi S.r.l. 766 26 - - (73) - - 719Roca S.r.l. (ex- M.S.M.C. Immobiliare Sei S.r.l.) - 368 - - (27) - - 341S.AN.CO S.c.a.r.l. - 2 - - - - 2Sicily Investments S.à.r.l. - 5 - - - - 5Solaris S.r.l. 9,463 - (5,391) - 236 - - 4,308Spazio Industriale B.V. 1,936 - (113) - 2,429 250 - 4,502Spazio Industriale II B.V. 3,674 6,060 (206) - 22,269 - (31,797) -Tamerice Immobiliare S.r.l. 3,475 (77) - - 11,385 - - 14,783Tizian Wohnen 1 GmbH 12 2,766 - - (14) - - 2,764Tizian Wohnen 2 GmbH 12 1,072 - - 64 - - 1,148Trinacria Capital S.à.r.l. - 5 - - - - 5Trinoro S.à r.l. - 11 - - (8) - - 3Trixia S.r.l. 2,359 - - - (1,561) - - 798Tronador - Consultoria Economica LdA 3,593 - - (3,605) 12 - - -Vespucci S.a.r.l. 1,348 1,112 - - 3,069 - - 5,529Vesta Finance S.r.l. - 12 - - - - 12Waterfront Flegreo S.p.A. - 173 - - (1) - - 172Olimpia S.p.A. 4,247,944 1,138,894 - - (1,940,039) 41,056 3,487,855

Total investments injoint ventures 4,459,967 1,201,628 (72,219) (49,165) (1,838,641) 250 9,599 3,711,419

TOTAL INVESTMENTS INASSOCIATES AND JOINTVENTURES 4,542,902 1,228,115 (87,188) (50,972) (1,836,411) (1,206) 30,688 3,825,928

Key data of the main associates and joint ventures of the real estate sector are as follows:

(in thousands of euros)Associates Joint venture

Non-current assets 701,319 1,747,663Current assets 940,116 6,112,156Non-current liabilities 747,976 3,930,602

Current liabilities 311,332 2,454,390Revenues from sales and services 371,703 3,387,096Costs (356,074) (3,743,147)Net income 3,818 415,997

The following amounts refers to the financial statements of the company Olimpia S.p.A., adjusted inaccordance with IFRS:

(in thousands of euros)OlimpiaNon-current assets 7,491,064Current assets 85,504

7,576,568Non-current liabilities 3,216,126Current liabilities 570

3,216,696

Revenues 429,144Costs (3,145,839)Loss (2,716,695)

137


The investments in joint ventures amount to Euros 3,711,419 thousand compared to Euros 4,459,968thousand at December 31, 2005. The amount mainly refers to the investment in Olimpia S.p.A. (80percent).In the above table of movements in joint ventures, the amount presented on the corresponding line inthe column “Other” (Euros 41,056 thousand) includes the fair value adjustment of the interest rateswaps designated as cash flows hedges (Euros 38,189 thousand) and other movements recognizeddirectly in equity relating to the investment in Telecom Italia S.p.A.; such amounts are recorded in thestatement of recognized income and expense in equity.

Although the interest held in Olimpia S.p.A. is higher than 50 percent, the investment qualifies as ajoint venture by virtue of the shareholders’ agreements and the bylaws, as described in the previousparagraph 5 “Estimates and assumptions”.

The investment held by Olimpia S.p.A. in Telecom Italia S.p.A., although below 20 percent, qualifies asan associate in that, considering Telecom Italia’s broad shareholder base, Olimpia’s investment allows itto exercise a significant influence. Therefore the investment is consolidated by the equity method.Olimpia S.p.A., under IFRS, holds 2,531,475,296 Telecom Italia S.p.A. ordinary shares (including124,129,937 shares relating to the equity swap on Telecom Italia S.p.A. shares), equal to a 13.04percent investment (18.92 percent of voting rights).

The impairment test of the Olimpia joint venture

The impairment test on the investment in Telecom Italia S.p.A. held by Olimpia S.p.A. was carriedout as described in the “Summary of significant accounting policies – impairment of assets”.IAS 36 Impairment of assets states that when there are indications of an impairment of an asset, the recoverable amount shall be estimated and compared with the carrying amount. Since therewere indications of an impairment in certain market parameters during the course of 2006, thecompany estimated the recoverable amount of the investment in Telecom Italia S.p.A. held throughOlimpia S.p.A..

The main indicators of an impairment in the recoverable amount which arose in 2006 can be ascribed to:a) the market price of Telecom Italia S.p.A. shares which recorded a relative negative performance

compared to the sector indexes in Europe and (most particularly) compared to the expectationsof Pirelli’s management;

b) the target prices of the analysts who follow Telecom Italia S.p.A. shares, which recorded a higherreduction than that recorded in the market price.

Having ascertained the effective existence of an impairment of the investment, in order to determinethe amount of the impairment, the recoverable amount of the investment in Telecom Italia S.p.A. wasdetermined by making reference to its value in use. In this specific case, moreover, the carryingamount used to compare the recoverable amount is represented by the carrying amount of theTelecom Italia S.p.A. ordinary shares implicit in the valuation of the investment by the equity methodused by Olimpia S.p.A..In estimating the value in use, since there is neither a preference nor a consolidated practice relatingto the two valuation techniques provided by IAS 28.33, the company decided to use both estimationcriteria in order to ensure a result consistent with a variety of calculation methods and measurementtechniques.These refer to:a) a criterion (the so-called asset side) which considers the operating flows of the associate and the

consideration received on the final disposal of the investment;b) a criterion (the so-called equity side) which considers the estimated flows from dividends and

from the disposal of the investment.In order to estimate the value in use all of the factors which market participants would haveconsidered have been taken into account. They refer, in particular, to:

138


a) flows of results (operating) and dividends as well as the discount and capitalization rates used bythe analysts (aligned with the consensus) who follow Telecom Italia S.p.A. stock;

b) multiples of comparable transactions, for the estimate of the final amount under the asset sidecriterion;

c) premiums paid in transactions involving listed companies operating in the telecommunicationssector in both Europe and the United States (the country where the sector concentration processfirst began) to estimate the consideration on the disposal of the shares under the equity sidecriterion.

The two criteria for estimating the value in use resulted in recoverable amounts of between Euros 3and 3.2 per Telecom Italia S.p.A. share. The company decided to adjust the carrying amount of theinvestment to an amount equivalent to Euros 3 per Telecom Italia S.p.A. ordinary share, which is animpairment loss of Euros 2,110,000 thousand.

Performance of the company Telecom Italia S.p.A. (an associate of Olimpia S.p.A.) during 2006The consolidated income of the Telecom Italia group in 2006 is Euros 3,014 million (Euros 3,003million before minority interests). In 2005, the consolidated income was Euros 3,216 million(Euros 3,690 million before minority interests).The change in consolidated income (-Euros 202 million) is due to the following factors:– operating loss (-Euros 62 million);– share of the earnings (losses) of investments in associates valued by the equity method

(+Euros 28 million);– lower net financial expenses (+Euros 14 million);– higher income taxes (-Euros 124 million);– lower net income from discontinued operations/assets held for sale (-Euros 543 million);– lower income attributable to the minority interest (+Euros 485 million), mainly as a result of the

TIM integration operation (cash tender offer and merger), which led to full control over Mobileoperations.

The net financial debt position amounts to Euros 37,301 million, with a decrease of Euros 2,557million compared to Euros 39,858 million at the end of 2005.The board of directors of Telecom Italia S.p.A. put forward a motion to the shareholders’ meeting topay out dividends equal to Euros 0.14 for each ordinary share.

11. AVAILABLE-FOR-SALE FINANCIAL ASSETS

Available-for-sale financial assets amount to Euros 1,006,898 thousand compared to Euros 1,032,317thousand at December 31, 2005.

Movements during the year are as follows:


Beginning amount 1,032,317 518,612Discontinued operations - (10,787)Adoption of IAS 32/39 - 225,667Increase 251,139 231,153Decrease (161,889) (12,567)Impairments (13,376) (22,391)(Gains) losses taken to income upon disposal of available-for-salefinancial assets, or impairments, previously recognized in equity (126,797) -Fair value adjustment gains (losses) recognized in equity 23,842 106,028Reclassifications 1,206 -Other 456 (3,398)

1,006,898 1,032,317

139


At December 31, 2006, available-for-sale financial assets include:• Euros 836,052 thousand of shares listed on the stock market and held in the portfolio of Pirelli &

C. S.p.A. and Pirelli Finance (Luxembourg) S.A.. Such shares refer to Telecom Italia S.p.A.,Mediobanca S.p.A., RCS Mediagroup S.p.A., Generale Industrie Metallurgiche S.p.A. and KMEGroup S.p.A;

• Euros 124,772 thousand of unlisted shares;• Euros 46,074 thousand of shares of closed-end property investment funds held by Pirelli & C. Real

Estate Società di Gestione del Risparmio S.p.A.

The increase is mainly due to the purchase of Telecom Italia S.p.A ordinary shares (Euros 186,209thousand), Assicurazioni Generali S.p.A. shares (Euros 4,567 million), Capitalia S.p.A. shares (Euros38,219 million), Mediobanca S.p.A. shares (Euros 13,545 million) and Banca Leonardo S.p.A. shares(Euros 4,598 million).

In addition to the increases, there were decreases for the sale of Capitalia S.p.A ordinary shares(Euros 117,669 million), F.C. Internazionale Milano S.p.A. shares (Euros 10,997 million), ConsortiumS.r.l. shares (Euros 14,699 million), Equinox shares (Euros 7,944 million) and Assicurazioni Generalishares (Euros 4,567 thousand).

Impairments mainly refer to the investments in Euroqube S.A. (Euros 2,181 thousand) andConsortium S.r.l. (Euros 4,532 thousand).

Net gains taken to income (Euros 126,797 thousand) mainly refer to the fair value adjustments ofCapitalia S.p.A shares previously recognized in equity (Euros 131,339 thousand) and reversed to theincome statement during the year at the time of sale.

For listed securities and closed-end property investment funds, the fair value corresponds to themarket prices at December 31, 2006.

For unlisted securities and closed-end property investment funds, the fair value has been estimatedusing appropriate estimation techniques.

12. DEFERRED TAX ASSETS AND LIABILITIES

These are composed as follows:


Deferred tax assets 64,230 82,300 Deferred tax liabilities (42,931) (54,606)

21,299 27,694

Since deferred tax assets and liabilities are offset in the financial statements when the income taxesare levied by the same tax authority and where there is a legally enforceable right of offset, thecomposition of the gross amounts is presented below:


Deferred tax assets 157,851- of which, recoverable within 12 months 66,561- of which, recoverable beyond 12 months 91,290Deferred tax liabilities (136,552)- of which, recoverable within 12 months (3,514)- of which, recoverable beyond 12 months (133,038)

21,299

140


Temporary differences which generate this caption at December 31, 2006 are as follows:


Deferred tax assets:- Provision for other liabilities and charges 34,973- Employee benefit obligations 36,763- Inventories 16,108- Tax loss carryforwards 13,806- Depreciation and amortization 4,243- Trade and other receivables 8,101- Trade and other payables 18,079- Intragroup transactions 9,027- Other 16,752Total 157,851

Deferred tax liabilities:- Depreciation and amortization (118,658)- Other (17,895)Total (136,552)

At December 31, 2006, deferred tax assets relating to temporary differences have not been calculatedfor an amount of Euros 358,160 thousand since they refer to situations in which recoverability is notconsidered probable.

Unused tax loss carryforwards, by expiration date, are as follows:

(in thousands of euros)Year of expiration2007 23,134 2008 147,350 2009 294,516 2010 156,798 2011 91,114 2012 50,298 2021 30,140 2022 68,887 2023 4,187 2024 10,162 without expiration 423,760

1,300,348

These losses, in most cases, refer to situations in which recoverability is not considered probable.Accordingly, deferred tax assets have been recognized in the financial statements for Euros 13,806thousand and the unrecognized portion is equal to Euros 415,624 thousand.

The tax effect of gains and losses recognized directly in equity is a negative Euros 6,935 thousandand is shown in the statement of recognized income and expenses in equity. These movements aremainly due to the tax effect of actuarial gains/losses on employee benefits and the fair valueadjustment of available-for-sale financial assets.

141


13. TRADE RECEIVABLES

Trade receivables are analyzed as follows:


Total Non- Current Total Non- Currentcurrent current

Associates and joint ventures 115,450 - 115,450 133,608 - 133,608Third parties 879,824 - 879,824 804,492 - 804,492Receivables on construction contracts 4,395 - 4,395 5,334 - 5,334

999,669 - 999,669 943,434 - 943,434

The costs incurred and the profit recognized on open contracts at December 31, 2006 amount toEuros 66,632 thousand (Euros 66,079 thousand at December 31, 2005), while billings in excess ofcosts of contracts in progress amount to Euros 62,237 thousand (Euros 60,745 thousand at December31, 2005).

The writedown of receivables, equal to Euros 13,620 thousand (Euros 9,808 thousand at December31, 2005), is recognized in the income statement under “Other expenses” (Note 33).

14. OTHER RECEIVABLES

Other receivables can be analyzed as follows:


Total Non- Current Total Non- Currentcurrent current

Associates and joint ventures- financial receivables 333,804 333,561 243 262,497 262,187 310 - other receivables 11,108 169 10,939 1,015 - 1,015

Financial receivables from third parties 246,896 219,935 26,961 232,860 206,254 26,606 Trade and other accrued income andprepaid expenses/third parties 18,949 249 18,700 17,069 250 16,819 Financial accrued income and prepaid expenses 13,542 7,999 5,543 14,845 6,176 8,669 Receivables from employees 6,882 3,373 3,509 5,241 2,308 2,933 Receivables from social security agencies 2,856 - 2,856 2,554 - 2,554 Receivables from tax authorities 74,592 10,348 64,244 62,171 9,405 52,766 Receivables for junior notes 94,177 94,177 - 16,669 16,669 - Other receivables 259,227 36,017 223,210 248,895 35,549 213,346

1,062,033 705,828 356,205 863,816 538,798 325,018

Non-current financial receivables from associates and joint ventures, equal to Euros 333,561thousand, refer to the real estate sector and are classified as non-current since the collection times,connected to the plans for the disposal of properties held directly and indirectly by the companies,will be concluded over a period of between two and five years. Such loans are made at rates in linewith those applied by the major market operators except for non-interest earning loans made tocertain non-operating companies or companies in a stage of transition for a total amount of Euros20,276 thousand at December 31, 2006 (Euros 35,181 thousand at December 31, 2005).

142


Non-current financial receivables from third parties mainly include a fixed-rate vendor loan maturingon January 28, 2016 granted to Prysmian (Lux) S.à.r.l. under the agreement reached on July 28, 2005between Pirelli and Goldman Sachs Capital Partners. This agreement regards the sale of the PirelliEnergy and Telecom Cables and Systems businesses (Euros 145,742 thousand). The increase from theend of last year (Euros 10,742 thousand) refers to the capitalization of interest earned between July28, 2005 and June 30, 2006. The reported amount approximates the fair value.

Pirelli was also assigned a warrant, expiring on January 28, 2016, entitling it to obtain economicbenefits equivalent to 5 percent of the capital of the vehicle company used by Goldman Sachs CapitalPartners for the purchase operation; this will allow Pirelli to take advantage of any opportunitiesarising from the future growth of the business.

Consequently, the warrant is treated as a contingent asset, the realization and the amount of whichdepends on the occurrence of future events, which by their very nature are uncertain.The recognition of a contingent asset in the financial statements assumes the existence of areceivable that is virtually certain in amount at the balance sheet date. Therefore, in the financialstatements at December 31, 2006, the warrant has not been measured.

Receivables for junior notes relate to the real estate sector. The increase of the amount compared tothe end of 2005, is due to the purchase of Class E and DPP junior notes by Pirelli & C. Real EstateS.p.A. on June 30, 2006 for Euros 80,000 thousand. The junior notes come from the securitization of anon-performing loan portfolio of the former Banco di Sicilia which is mainly composed of receivablesfor loans guaranteed by properties and by unsecured receivables for the remaining part.

As a result of the merger of Partecipazioni Real Estate S.p.A., Pirelli & C. Real Estate S.p.A. acquiredClass C junior notes worth Euros 10,701 thousand, relating to the securitization of a non-performingloan portfolio held by the company Cairoli Finance S.r.l., and Class D2 junior notes for Euros 6,707thousand, relating to the securitization of a non-performing loan portfolio of the company LSF ItalianFinance Company S.r.l.; the latter was sold to third parties on December 29, 2006.

Other current receivables principally refer to the real estate sector and include advances made forthe acquisition of Deutsche Grunvermogen AG - DGAG (one of the most important real estatecompanies in Germany with offices in Hamburg and Kiel) for Euros 140,000 thousand, non-performing loan receivables (Euros 16,011 thousand), dividends to be collected (Euros 3,029thousand) and regional grants which will be paid by the Campania region to aid buyers of propertyunits owned by the company Geolidro S.p.A. (Euros 10,259 thousand).

15. TAX RECEIVABLES

Tax receivables amount to Euros 44,349 thousand (of which Euros 10,917 thousand is non-current)compared to Euros 67,409 thousand at December 31, 2005 (of which Euros 9,214 thousand isnon-current).

143


16. INVENTORIES

Inventories may be analyzed as follows:


Tyres Sector 590,925 546,287 Real Estate Sector 120,642 128,768 Other 3,966 6,001

715,533 681,056

12/31/2006 12/31/2005Raw materials, auxiliaries and consumables 190,101 161,812 Sundry materials 1,774 4,086 Work in process and semifinished products 66,629 94,686 Finished products 195,073 172,581 Merchandise purchased for resale 216,811 201,420 Land to be developed 37,795 22,102 Advances 7,350 24,369

715,533 681,056

Inventories include capitalized borrowing costs of Euros 4,110 thousand at December 31, 2006(Euros 4,270 thousand at December 31, 2005).The writedown of inventories made in 2006 amounts to Euros 2,530 thousand.

17. SECURITIES HELD FOR TRADING

Securities held for trading amount to Euros 119,174 thousand and include the following:

– Euros 94,995 thousand of variable rate bonds issued and guaranteed by banking institutions;

– Euros 4,417 thousand of fixed rate bonds;

– Euros 19,762 of equity securities intended for sale.

The positions are held at leading banks.

For listed securities, the fair value corresponds to the market price at December 31, 2006.For unlisted securities, the fair value was estimated using appropriate estimation techniques.

The fair value adjustments are recognized in the income statement under “valuation of financialassets” (Note 37).

18. CASH AND CASH EQUIVALENTS

Cash and cash equivalents are concentrated in the financial companies, the holding companies andthe subholding companies of the Group. They are mainly invested in short-term deposits held byleading banking counterparts at interest rates reflecting market rates.For the purpose of the statement of cash flows, the balance of cash and cash equivalents is shownnet of bank overdrafts, equal to Euros 10,185 thousand at December 31, 2006 and Euros 154,021thousand at December 31, 2005.

144


19. EQUITY

19.1 ATTRIBUTABLE TO THE EQUITY HOLDERS OF THE COMPANY

“Share capital” amounts to Euros 2,789,950 thousand at December 31, 2006 and consists of5,233,142,003 ordinary shares and 134,764,429 savings shares, all with a par value of Euros 0.52 pershare and normal dividend rights.The changes in share capital are detailed below:

Number of Number of Ordinary Savings Totalordinary savings shares shares

shares shares(thousands)(*) (thousands) (€€ thousands) (€€ thousands) (€€ thousands)

Balance at December 31, 2005 5,178,112 134,764 2,692,619 70,077 2,762,696 Exercise of warrants 52,412 - 27,254 - 27,254 Balance at December 31, 2006 5,230,524 134,764 2,719,873 70,077 2,789,950 (*) Net of 2,617,500 treasury shares in portfolio.

Changes in equity are as follows:

145


(in millions of euros)attributable to the equity holders of the company

Share Share Legal Reserve for Reserve for Other Total Minority Totalcapital premium reserve translation fair value reserves/ attributable interest

reserve differences adjustment Retained to equity of AFS earnings holders of assets company

Balance at 1/1/2005 1,799 500 75 24 - 1,241 3,639 339 3,978

Total recognized income and expenses in equity - - - 174 106 19 299 6 305Income for the year 327 327 72 399 Appropriation of income as per resolution of 4/28/2005:- legal reserve 7 (7) - - - - dividend payment (113) (113) - (113)Other dividends paid to third parties - (36) (36)Exercise of warrants 2003-2006 175 (174) 1 - 1 Pirelli & C. share capital increase 789 259 1,048 - 1,048 PRE stock options exercised in the year - 8 8 Yanzhou Evolution Tyre CO Ltd Consolidation - 21 21 Other 4 4 (1) 3 Balance at 12/31/2005 2,763 759 82 198 106 1,297 5,205 409 5,614

Total recognized income and expenses in equity - - - (79) (110) 90 (99) (16) (115)Loss for the year (1,167) (1,167) 118 (1,049)Appropriation of income as per resolution of 4/21/2006:- legal reserve 7 (7) - - - - dividend payment (114) (114) - (114)Other dividends paid to third parties - (49) (49)Exercise of warrants 2003-2006 27 27 - 27Movements in Pirelli & C. Real Estate S.p.A.treasury shares 25 25 23 48P.Tyre minority interest stake soldby private placement - 295 295PRE stock options exercised in the period 2 2 29 31 Acquisition of interests from minority interest - (7) (7)Minority interest share capital increase - 7 7 Other 1 1 (2) (1)Balance at 12/31/2006 2,790 759 89 119 (4) 127 3,880 807 4,687

19.2 ATTRIBUTABLE TO THE MINORITY INTEREST

The minority interest in equity went from Euros 408,947 thousand at December 31, 2005 to Euros806,966 thousand at December 31, 2006. The change is mainly due to the interest in Pirelli Tyre S.p.A.sold with a private placement in addition to the net balance between the result for 2006, the paymentof dividends referring to the prior year and the impact of the translation of foreign currency financialstatements to euros.

The major percentages of investments held by minority interests are as follows:

12/31/2006 12/31/2005Shared Service Center s.c.a r.l. (Italy) 50.00% 50.00%Drahtcord Saar Gmbh & Co. K.G. (Germany) 50.00% 50.00%Celikord A.S. (Turkey) 49.00% 49.00%Pirelli & C. Ambiente S.p.A. (già Pirelli & C. Ambiente Holding S.p.A.) (Italy) 49.00% 49.00%Pirelli & C. Real Estate S.p.A. (Italy) 49.42% 46.74%Pirelli Tyre Co. Ltd (già Yanzhou Evolution Tyre CO. Ltd) (China) 40.00% 40.00%Pirelli Tyre S.p.A. (Italy) 38.94% -Turk Pirelli Lastikleri A.S. (Turkey) 34.41% 36.94%S.C. Cord Romania S.R.L (Romania) 20.00% 20.00%Alexandria Tire Co. S.A.E. (Egypt) 10.90% 13.19%Pirelli de Venezuela C.A. (Venezuela) 3.78% 3.78%

20. STOCK OPTION PLANS

During the year ended December 31, 2006, the company did not introduce any stock option plans.Pirelli & C. S.p.A. has two existing stock option plans for the senior executives and staff ofPirelli & C. S.p.A. and other companies of the Group which were granted option rights, nottransferable to third parties, for the subscription/purchase of Pirelli & C. S.p.A. ordinary shares.

The following disclosure is provided on the above plans called Pirelli to People and Group SeniorExecutives.

146


Features of theplan

Recipients atDecember 31, 2006

Conditions forexercising options

Subscription/purchaseprice per share

Pirelli to People

Option rights granted, non-transferable to thirdparties, for the subscription of future new issuesof Pirelli & C. ordinary shares or, as decided bythe latter, for the purchase of treasury shares ofPirelli & C.

288 employees (senior executives, cadres, keyemployees) of the companies of the Group.Originally 725 persons at the date of approval ofthe plan.

Continuance of employment.

Each option right granted gives the right tosubscribe/purchase one Pirelli & C. ordinaryshare at the price of Euros 1.150 (1).

Group Senior Executives

Option rights granted, non-transferable to thirdparties, for the subscription of future new issuesof Pirelli & C. ordinary shares or, as decided bythe latter, for the purchase of treasury shares ofPirelli & C.

28 senior executives of the companies of theGroup.Originally 51 persons at the date of approval ofthe plan.

(a) continuance of employment, and (b) thereaching, in the two-year period 2001-2002, ofspecific targets, assigned to each recipient.

Each option right granted gives the right tosubscribe/purchase one Pirelli & C. ordinaryshare at the price of Euros 1.150 (1).

(1) This amount was changed (from Euros 1.284) on the basis of the adjustment factor established by AIAF on February 7, 2005 following thecapital increase approved by the special shareholders’ meeting held on January 21, 2005, in accordance with the Regulations of those StockOption Plans in the event of transactions involving share capital.

The following table shows the changes in the above plans, the number of option rights and theexercise price.

Pirelli to PeopleTable 1 Year 2006 Year 2005

Number of Average Market price Number of Average Market price shares exercise price in € shares exercise price in €

in € in €Rights existing at 1/1/2006 21,693,205 1,15 (1) 0,77 36,826,541 1,284 0.99Rights granted during year - - - - - - (rights exercised during year) - - - - - -(Rights forfeit during the year2006 as a result of personsleaving the Group) 1,304,001 - - 15,133,336 - -Rights existing at12/31/2006 20,389,204 1.15 (1) 0.75 21,693,205 1.15 (1) 0.77

Table 2 Rights granted – existing at December 31, 2006 Exercise price Remaining contractual life Of which exercisable

>2 years * Total From 11/5/2004€ 1.15 (1) 20,389,204 20,389,204 20,389,204

* until 11/5/2010

(1) This amount was changed to Euros 1.150 on the basis of the adjustment factor established by AIAF on February 7, 2005 following the capital increase approvedby the special shareholders’ meeting held on January 21, 2005, in accordance with the Regulations of those Stock Option Plans in the event of transactions involvingshare capital.

147


Vesting period ofoptions

Maximum number ofoptions for which theoffer was open atDecember 31, 2005

Maximum number ofoptions for which theoffer was open atDecember 31, 2006

Options forfeit during2006 as a result ofpersons leaving theGroup

Shares issued duringthe period

Pirelli to People

Up to nine years from the date the options aregranted (which took place on November 5,2001), but not before one year has passed fromthat date for 50 percent of the options granted,two years for another 25 percent and three yearsfor the remaining 25 percent.

21,693,205 options equal to about 0.4 percent ofoutstanding ordinary shares destined for 309recipients.


1,304,001

None

Group Senior Executives

As regards the options granted on November 5,2001, up to nine years from the date the optionsare granted, but not before one year has passedfrom that date for 50 percent of the options, twoyears for another 25 percent and three years forthe remaining 25 percent. For the optionsgranted definitively on May 10, 2002, up to May31, 2009 but not before June 1, 2002 for 50percent of the options and not before January 1,2003 for the remaining 50 percent.



1,589,334

None

Group Senior ExecutivesTable 1 Year 2006 Year 2005

Number of Average Market price Number of Average Market price shares exercise price in € shares exercise price in €

in € in €Rights existing at 1/1/2006 13,986,882 1.15 (1) 0.77 17,399,309 1.284 0.99Rights granted during year - - - - - - (rights exercised during year) - - - - - -(Rights forfeit during the year2006 as a result of personsleaving the Group) 1,589,334 - - 3,412,427 - -Rights existing at12/31/2006 12,397,548 1.15 (1) 0.75 13,986,882 1,15 (1) 0.77

Table 2 Rights granted – existing at December 31, 2006 Exercise price Remaining contractual life Of which exercisable

>2 years * Total From 11/5/2004€ 1.15 (1) 12,397,548 12,397,548 12,397,548

* until 5/31/2009

(1) This amount was changed to Euros 1.150 on the basis of the adjustment factor established by AIAF on February 7, 2005 following the capital increase approvedby the special shareholders’ meeting held on January 21, 2005, in accordance with the Regulations of those Stock Option Plans in the event of transactions involvingshare capital.

The following tables indicates the number of rights granted under the above-described incentiveplans, held at December 31, 2006, directly and indirectly, by the members of the board of directors,the board of statutory auditors, general managers and key managers of the Company and itssubsidiaries.

Name Rights held Rights granted Rights exercised Rights heldat 1/1/2006 during during at 12/31/2006

year 2006 year 2006No. of Average No. of Average No. of Average No. of Averagerights exercise rights exercise rights exercise rights exercise

price price price priceClaudio De Conto 778,774(1) 1.15(3) - - - - 778,774(1) 1.15(3)

410,667(2) 1.15(3) - - - - 410,667(2) 1.15(3)

Luciano Gobbi 778,774(1) 1.15(3) - - - - 778,774(1) 1.15(3)

360,000(2) 1.15(3) - - - - 360,000(2) 1.15(3)

Francesco Gori (4) 533,334(1) 1.15(3) - - - - 533,334(1) 1.15(3)

666,667(2) 1.15(3) - - - - 666,667(2) 1.15(3)

(1) Group Senior Executives incentive plan.(2) Pirelli to People incentive plan.(3) This amount was changed to Euros 1.150 on the basis of the adjustment factor established by AIAF on February 7, 2005 following the capital increase approved

by the special shareholders’ meeting held on January 21, 2005, in accordance with the Regulations of those Stock Option Plans in the event of transactionsinvolving share capital.

(4) Francesco Gori, starting from July 1, 2006, took over the post of chief executive officer and general manager of the subsidiary Pirelli Tyre S.p.A..The Deputy Chairman Carlo Alessandro Puri Negri is the grantee of stock options as the chief executive officer of Pirelli & C. Real Estate S.p.A..Carlo Buora, starting November 6, 2006 – after relinquishing all the posts held in the Company – is no longer a grantee of any option rights.

Giovanni Ferrario (chief executive officer and general manager of the Company since December2004) holds 1,333,334 option rights granting the right to subscribe/purchase to the same number ofPirelli & C. S.p.A. ordinary shares at the price of Euros 1.15 each.

Valerio Battista (general manager of the Company since June 2005) holds 1,650,134 option rightsgranting the right to subscribe/purchase to the same number of Pirelli & C. S.p.A. ordinary shares atthe price of Euros 1.15 each.

148


Plans put in place by the subsidiary Pirelli & C. Real Estate S.p.A. and by itssubsidiaries

The company, in order to permanently involve its staff and management in increasing the value ofPirelli & C. Real Estate S.p.A., approved a stock option plan on May 9, 2002 (hereinafter “Plan 2002”),which ended on December 15, 2006.On February 24, 2004, the company – partly in consideration of the expiration date of the exercise

periods for Plan 2002 – approved a new stock option plan (hereinafter “Plan 2004”) on behalf of thedirectors and employees of the Pirelli RE group (hereinafter “Group”), as an added incentive and toincrease a sense of loyalty, partly with view towards the development of new business areas – amongwhich, the placement of mutual funds and non-performing loan activities – that the Group ispursuing.Lastly, on December 16, 2005, a new stock option plan was approved (hereinafter “Plan 2006”) fordirectors and employees of the Group. The plan is an added incentive to increase their loyalty whilebearing in mind the important targets fixed in that three-year 2006-2008 Plan which provide – besidesa renewed dynamics in the development and in the consolidation of the traditional residential andcommercial sectors, specialist services, the promotion and management of property investment funds– also: (i) an appreciable growth in the non-performing loan sectors; (ii) a clear and significant slanttowards foreign markets; (iii) the innovative promotion and management of speculative funds;(iv) the growth of the franchising network’s contribution to the Group’s overall results and, in general(v) an overall annual increase in the long-term component of the business as compared to thetraditional short-term component, with an annual growth in results of 10 – 15 percent. The new Plan2006 was also designed by considering the expiration dates of the exercise periods of Plan 2004.The most important information about the stock option plans of the Group is provided as follows:

PLAN 2002

Plan features: granting of option rights, non-transferable to third parties, for the subscription of newPirelli & C. Real Estate S.p.A. ordinary shares following the capital increase approved to service thisplan.Grantees: 88 persons (directors, executives and cadres) of Pirelli & C. Real Estate S.p.A. and itssubsidiaries.Conditions for exercising the options rights: (a) continuance of the employment relationship withone of the above companies, (b) continued status of the company, in which the person is anemployee or a director, as a company of the Group headed by Pirelli & C. S.p.A. (c) achievement ofthe specific targets assigned to each grantee during the three-year period 2002-2004.Per share subscription price: Euros 26; this price may vary as a result of share capital increasesunconnected with the Plan or in the case of mergers, spin-offs or amendments to the bylawsaffecting the rights of the grantees.Option exercise period: 50 percent of the options can be exercised from July 1, 2004 to December 15,2006 and the remaining 50 percent from July 1, 2005 to December 15, 2006; all options must beexercised by December 15, 2006.Maximum number of shares covered by the plan: 2,150,000, of which 2,053,000 have been assigned.There were 530,250 rights remaining at January 1, 2006; during 2006, 522,250 rights were exercised.There were 8,000 rights remaining at December 15, 2006, which are now forfeit since – in conformitywith regulations – the plan ended on December 15, 2006.At the time of transition to IFRS, IFRS 2 was not adopted for this plan since it was approved beforeNovember 7, 2002.

149


PLAN 2004

Plan features: granting of option rights, non-transferable to third parties, for the purchase of Pirelli &C. Real Estate S.p.A. ordinary shares held by the company (treasury shares).Grantees: 50 persons (directors, executives and cadres) of Pirelli & C. Real Estate S.p.A. and itssubsidiaries.Conditions for exercising the options rights: (a) continuance of the employment relationship orstatus as a director with Pirelli & C. Real Estate S.p.A. or another company controlled, directly orindirectly, by the same company (b) share performance by Pirelli & C. Real Estate S.p.A. sharesbetter than the European Public Real Estate Association (EPRA), Europe Return Index.Per share purchase price: Euros 26.75, which corresponds to the fair value of the share on the grantdate. This price may vary as a result of share capital increases or other extraordinary transactions,but in every case ensuring the equivalent rights held by the grantees before those transactions.Option exercise period: 50 percent of the options can be exercised from July 1, 2006 to December 15,2007 (first tranche) and the remaining 50 percent from July 1, 2007 to December 15, 2007 (secondtranche); all options must be definetely exercised by December 15, 2007.Maximum number of shares covered by the plan: 1,000,000.There were 947,000 rights remaining at January 1, 2006; during 2006, 14,000 rights were forfeit as aresult of the termination of employment and 469,000 rights were exercised. Consequently, there were464,000 options granted remaining at December 31, 2006.The fair value of the options on the grant date, equal to Euros 2.50 for the first tranche and Euros2.69 for the second tranche, was determined using the Monte-Carlo model.The assumptions which were considered in the valuation model can be summarized as follows:- weighted average price of the shares at the grant date equal to Euros 26.75, equal to their per share

exercise price;- estimated volatility of 22 percent determined on the basis of the historical volatility of the price of

the shares from the time Pirelli & C. Real Estate S.p.A. was listed up to the grant date of this plan;- estimated period of the rights equal to 3 years for the first tranche and 3 and a half years for the

second;- estimated dividends equal to 6 percent;- risk-free interest rate equal to 3 percent.

PLAN 2006

Plan features: granting of option rights, non-transferable to third parties, for the purchase of Pirelli &C. Real Estate S.p.A. ordinary shares held by the company (treasury shares).Grantees: 70 persons (directors, executives and other key resources) of Pirelli & C. Real Estate S.p.A.and its subsidiaries.Conditions for exercising the options rights: (a) continuance of the employment relationship orstatus as a director in the companies of the Pirelli Group (b) the reaching/exceeding, when the rightsare exercised, of a minimum market price of the Pirelli & C. Real Estate S.p.A. share, which must notbe lower than Euros 55.00 [market restriction], (c) average annual growth of the Operating ResultParameter (PBIT) + Income from investment holdings (IEP) not less than 10 percent [operatingrestriction].Per share purchase price: Euros 46.50, which corresponds to the fair value of the share on the grantdate; this price may vary as a result of share capital increases or other extraordinary transactions,but in every case ensuring the equivalent rights held by the grantees before those transactions.Option exercise period: 40 percent of the options can be exercised from July 1, 2008 to December 15,2009 (first tranche) and the remaining 60 percent from July 1, 2009 to December 15, 2009 (secondtranche); all options must be exercised by December 15, 2009. The options may be exercised inadvance, in the event of a "change of control” and, as a result of which, Pirelli & C. S.p.A. would no

150


longer be the majority shareholder of the company. However, the market and operating restrictionsremain in place, with predetermined criteria to be applied in relation to the exercise of the options ifthe event should occur.On March 9, 2007, the board of directors approved the extension of the vesting period for the firsttranche of this plan from July 1, 2008 to December 18, 2008 and keeping the closing date unchangedat December 15, 2009.The change was necessary in order to allow the grantees of the plan to exercise the their stockoptions in conformity with the new tax regime on the subject, introduced by Decree Law 262 datedOctober 2, 2006, which calls for a minimum vesting period of three years.Since this change had no effect on the basic elements of the plan, the fair value of the plan was notincreased and therefore the accounting amount remained the same.Maximum number of shares covered by the plan: 1,800,000.The fair value of the options on the grant date, equal to Euros 5.90 for the first tranche and Euros5.27 for the second tranche, was determined using the Black-Scholes model.The assumptions which were considered in the valuation model can be summarized as follows:- weighted average price of shares at the grant date equal to Euros 46.50, equal to their per share

exercise price;- estimated volatility of 23 percent determined on the basis of the historical volatility of the price of

the shares from the time Pirelli & C. Real Estate S.p.A. was listed up to the grant date of this plan;- estimated period of the rights equal to 3 years and 3 months for the first tranche and 3 years and 9

months for the second;- estimated dividends equal to 5 percent;- risk-free interest rate equal to 3.07 percent.The assumptions that were considered in the valuation model take into account the fair amount ofthe shares at the grant date (Euros 46.50) equal to the per share exercise price of the shares and theestimated volatility of 23 percent determined on the basis of the historical volatility of the price ofthe shares from the time Pirelli & C. Real Estate S.p.A. was listed up to the grant date of this plan.The table below – in conformity with Scheme 2 of Attachment 3C of Consob Regulation 11971/1999 –shows the movements in the stock options held by the directors and general managers Pirelli & C.Real Estate S.p.A. during 2006.

151


Rights Rights Rights Rights Rightsheld at granted exercised expired/forfeit held at

1/1/2006 in 2006 in 2006 in 2006 12/31/2006(A) (B) (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)=(1)+(4)-(7)-(10) (12) (b)Name Position Number Average Expiration Number Average Due date Number Average Average Number Number Average

of exercise of exercise of exercise exercise of of exerciseoptions price options price options price market options options price

priceCarlo Alessandro Chief ExectivePuri Negri Officer 982,500 32.45 12/15/09 - - - 555,000 26.17 52.53 - 427,500 40.61Carlo Bianco Deputy Chairman 257,000 37.42 12/15/09 - - - 74,000 26.44 54.77 - 183,000 41.86Emilio Biffi Managing Director

Chief TechnicalOfficer 226,000 38.98 12/15/09 - - - 43,000 26.75 52.60 40,000 (a) 143,000 41,86

Olivier de DirectorPoulpiquet 400,000 36.63 12/15/09 - - - 100,000 26.75 52.60 - 300,000 39.92(a) Options forfeit after relinquishing post.(b) The average exercise price takes into account the average values referring to plans 2004 and 2006.

Stock option plans by subsidiaries of Pirelli & C. Real Estate S.p.A.

On July 31, 2003, Giulio Malfatto, a director of Pirelli & C. Real Estate S.p.A., upon his appointmentas the chief executive officer of Pirelli & C. Real Estate Società di Gestione del Risparmio S.p.A.,was offered an option for the purchase of ordinary shares representing 3 percent of the share capitalof Pirelli & C. Real Estate Società di Gestione del Risparmio S.p.A., to be executed by a share capitalincrease to service this option. The option is an integral part of Giulio Malfatto’s compensation as thechief executive officer of Pirelli & C. Real Estate Società di Gestione del Risparmio S.p.A..

The option was exercisable:

a) at the expiry of the first three-year term of his appointment as the chief executive officer of Pirelli& C. Real Estate Società di Gestione del Risparmio S.p.A. and for the following six months, or

b) from an earlier date in the case of revocation without a just cause, or dismissal with a just causefrom the post of chief executive officer of Pirelli & C. Real Estate Società di Gestione delRisparmio S.p.A., until the expiry date mentioned in point a), or

c) within three months from December 31, 2005, if at that date the value of the assets managed byPirelli & C. Real Estate Società di Gestione del Risparmio S.p.A. is lower than Euros 3 billion.

The exercise of the option, in the event indicated in the previous letter a), was subject to theverification of having reached certain targets (in terms of profitability, assets managed, etc.)established by the same board of directors of Pirelli & C. Real Estate Società di Gestione delRisparmio S.p.A..The exercise price of the option was equal to the fair value of 3 percent of Pirelli & C. Real EstateSocietà di Gestione del Risparmio S.p.A. shares at the date of July 31, 2003, resulting from a specificappraisal. This price could have varied in relation to subsequent increases in share capital, if any,approved and subscribed to, in order for the chief executive officer to have an option right equalto 3 percent of the resulting capital at the date of the exercise of the option.In June 2006, in conformity with the contract clauses, the option was exercised. The exercise pricewas equal to the fair value of 3 percent of the Pirelli & C. Real Estate Società di Gestione delRisparmio S.p.A. shares determined on the basis of a specific appraisal by Credit Suisse.The board of directors of Pirelli & C. Real Estate S.p.A., on November 7, 2003, also approved

stock option plans for 33 executive and directors of some wholly-owned service companies of Pirelli& C. Real Estate S.p.A.. These plans do not include the directors and general managers of the parent.For all the plans approved, the exercise prices were determined on the basis of specific appraisals todetermine the fair value of the companies. The option rights can be exercised in the months of April2005 and April 2006, but are contingent on several factors, including the reaching of performancetargets that are higher than those established in the plan 2003-2005. Furthermore, there is a put andcall mechanism in place for the repurchase of the shares connected with the exercise, if any, of theoptions.

There were 41,160 option rights granted on January 1, 2006 relating to the various servicecompanies; during 2006, 20,474 option rights were exercised and 20,686 rights expired. Consequentlyat December 31, 2006, there are no remaining options.The board of directors of Pirelli & C. Real Estate Franchising Holding S.r.l. approved a stock option

plan for 10 directors and employees of its wholly-owned subsidiary Pirelli & C. Real EstateFranchising S.p.A. on June 29, 2004. This plan does not include the directors and general managers ofthe parent. The plan provides for granting 12,167 option rights for the purchase of Pirelli & C. RealEstate Franchising S.p.A. shares (equal to 2.43 percent of the share capital) at the exercise price pershare of Euros 119.90.The exercise price was determined on the basis of a specific appraisal to determine the fair value of

the company. The option rights can be exercised in the months of April 2006 (first tranche) and April2007 (second tranche) but are contingent on several factors, including the reaching of performance

152


targets. Furthermore, there is a put and call mechanism in place for the repurchase of the sharesconnected with the exercise, if any, of the options.There were 9,420 option rights granted on January 1, 2006, during 2006, 3,354 option rights wereexercised and 414 option rights were forfeit. Consequently, there were 5,652 option rights grantedremaining at December 31, 2006.Lastly, the board of directors of Pirelli & C. Real Estate S.p.A. approved a stock option plan forexecutives and other employees of Pirelli & C. Real Estate Società di Gestione del Risparmio S.p.A.,a subsidiary of Pirelli & C. Real Estate S.p.A. on July 28, 2004. This plan does not include thedirectors and general managers of Pirelli & C. Real Estate S.p.A.. The plan was adopted at a laterdate, compared to the other service subsidiaries, in order to include the executives and otheremployees of Pirelli & C. Real Estate Società di Gestione del Risparmio S.p.A. in incentivemechanisms that had not been included in the previous plans introduced by the parent, since thesecompanies had been in the start-up phase, and thus bring their compensation packages into line witha consistent policy within the Group.The stock option plan for the subsidiary Pirelli & C. Real Estate Società di Gestione del RisparmioS.p.A. is for 11 executives and other employees and provides for a maximum of 170,523 options to begranted for the purchase of the Pirelli & C. Real Estate Società di Gestione del Risparmio S.p.A.shares (equal to 2.07 percent of the share capital) at the exercise price per share of Euros 17.47.Also in this case, the exercise price was determined on the basis of a specific appraisal to determinethe fair value of the company. The options can be exercised during the period April 1, to April 30,2007, but are contingent on several factors, including the reaching of performance targets.Furthermore, there is a put and call mechanism in place for the repurchase of the shares connectedwith the exercise, if any, of the options.The options rights granted and remaining at January 1, 2006 total 73,284 and there were no changesduring 2006.At December 31, 2006, the fair value of the existing cash-settled stock option plans relating tosubsidiaries amount to Euros 1,384 thousand (Euros 11,743 thousand at December 31, 2005),calculated by assuming an implicit volatility determined on the basis of the projection of theeconomic capital of the company involved in the stock option plans.

Plans relating to the subsidiary Pirelli & C. Ambiente S.p.A. and its subsidiaries

During 2006, there were changes to the stock option plan approved by the boards of directors ofPirelli & C. Ambiente Renewable Energy S.p.A. (ex-Pirelli & C. Ambiente S.p.A.) and its parent Pirelli& C. Ambiente S.p.A. (ex-Pirelli & C. Ambiente Holding S.p.A.), effective January 2006. The plan callsfor granting purchase options for a total of 306,000 Pirelli & C. Ambiente S.p.A. shares to ninegrantees, equal to 10 percent of the share capital of the latter company, at the per share price ofEuros 1.85, on the basis of an appraisal carried out for this purpose.

All the above options can be exercised in April 2009, subject to reaching specific corporate targetsby the date of December 31, 2008, or, in September 2009, in the case those targets are reached byJune 30, 2009. The shares from exercising the option can be sold by the grantees to Pirelli & C.Ambiente S.p.A. within one month of exercising the options at a price that will take into accountthe revaluation of the net asset value of the company during the period.At December 31, 2006, the fair value of the existing cash-settled stock option plan amounts toEuros 225 thousand. This has been calculated on the basis of the projection of the economic capitalof the company to which the stock option plan refers.

153


21. TAX PAYABLES

Tax payables amount to Euros 58,477 thousand (of which Euros 9,708 thousand is non-current)compared to Euros 44,858 thousand at December 31, 2005 (of which 2,650 thousand is non-current).

22. PROVISIONS FOR OTHER LIABILITIES AND CHARGES

The movements during the year in provisions for other liabilities and charges are presented in thefollowing table:

(in thousands of euros)Provisions for other liabilities and charges - non-currentBeginning balance at 1/1/2006 170.561 Exchange differences (1.560)Increase 21.734 Utilization/Release (14.440)Reclassification (36.000)Other 4.824 Ending balance at 12/31/2006 145.119

(in thousands of euros)Provisions for other liabilities and charges - currentBeginning balance at 1/1/2006 53.999 Exchange differences (2.185)Increase 44.496 Utilization/Release (26.794)Reclassification 36.000 Other 11.009 Ending balance at 12/31/2006 116.525

At December 31, 2006, the non-current portion mainly includes Euros 76,616 thousand relating to theaccruals for the legal and tax disputes of the subsidiary Pirelli Pneus S.A. with headquarters in Brazil,Euros 32,689 thousand for the risks of a fiscal nature of the parent Pirelli & C. S.p.A. and Euros11,916 thousand for contractual commitments undertaken for the performance of extraordinarymaintenance work on buildings sold.

The current portion primarily refers to:- accruals for the price adjustments covered by the contract for the sale of Pirelli’s operations in the

Energy and Telecom Cables and Systems sector to Goldman Sachs Capital Partners in July 2005 andguarantees provided (Euros 66,000 thousand);

- accruals for contractual guarantees and product claims (Euros 12,940 thousand).

23. EMPLOYEE BENEFIT OBLIGATIONS

These include:


Pension funds:- funded 156,271 236,536- unfunded 99,887 104,889Employees’ leaving indemnity 96,824 100,099Medical care plans 28,362 33,386Other benefits 34,506 35,892

415,850 510,802

154


- Pension funds

The composition of pension funds, at December 31, 2006, is as follows:(in thousands of euros)

12/31/2006Germany Total USA UK Total

unfunded unfundedpension funds pension funds

FundedPresent value of funded obligations 146,708 947,160 1,093,868Fair value of plan assets (113,136) (824,461) (937,597)UnfundedPresent value of unfunded obligations 99,887 99,887Net liability in the balance sheet 99,887 99,887 33,572 122,699 156,271of which:- Tyres 99,887 99,887 33,572 62,071 95,643- Other 60,628 60,628

The composition of pension funds, at December 31, 2005, was as follows:(in thousands of euros)

12/31/2005Germany Total USA UK Total

unfunded unfundedpension funds pension funds

FundedPresent value of funded obligations 169,606 924,787 1,094,393Fair value of plan assets (117,610) (740,247) (857,857)UnfundedPresent value of unfunded obligations 104,889 104,889Net liability in the balance sheet 104,889 104,889 51,996 184,540 236,536of which:- Tyres 104,889 104,889 51,966 74,504 126,500- Other 110,036 110,036

The main features of the pension plans existing at December 31, 2006 are as follows:• Germany: this is an unfunded defined benefit plan based on the most recent remuneration. It

guarantees another pension besides the government pension. The plan was closed in October 1982;consequently, the participants in the plan are employees who were hired prior to that date.

• USA: this is a funded defined benefit plan based on the most recent remuneration. It guaranteesanother pension besides the government pension. The plan is under the administration of a trust.The plan was closed in 2001 and frozen in 2003 for those employees who passed over to a definedcontribution scheme. None of the current participants in the plan are in service.

• UK: these are funded defined benefit plans based on the most recent remuneration. They guaranteeanother pension besides the government pension. The plans are under the administration of a trust.The plans were closed in 2001; consequently, the participants in the plan are employees who werehired prior to that date.

The changes during the year in the present value of the liabilities for pension funds (funded andunfunded) are as follows:


Beginning balance 1,199,282 1,079,679 Discontinued operations - (80,475)Exchange differences 1,645 45,378 Movements through the income statement 60,963 62,281 Actuarial (gains)/losses recognized in equity (13,413) 148,562 Employee contribution 1,774 2,854 Benefits paid (56,451) (58,997)Other (45) - Closing balance 1,193,755 1,199,282

155


The changes during the year in the fair value of the pension plan assets are as follows:


Beginning balance (857,857) (735,645)Discontinued operations - 26,271 Exchange differences (3,371) (33,627)Movements through the income statement (58,374) (55,026)Actuarial (gains)/losses recognized in equity (33,029) (75,420)Employee contribution (32,906) (33,484)Employee contribution (1,774) (2,854)Benefits paid 49,679 51,928 Other 35 -Closing balance (937,597) (857,857)

The composition of the funded pension plan assets is presented in the following table:

12/31/2006 12/31/2005UK USA UK USA

Shares 82% 68% 80% 68%Bonds 15% 29% 17% 30%Deposits 1% 3% 1% 2%Other 2% - 2% -

100% 100% 100% 100%

The effective return of pension plan assets is as follows:

(in thousands of euros)USA UK Total

Effective return 2006 10,931 80,175 91,106 Effective return 2005 5,843 125,006 130,849

The amounts recognized in the income statement for pension funds are as follows:


Current service costs 4,713 7,006Interest cost 56,250 55,342Expected return on plan assets (58,374) (55,093)

2,589 7,255

The amounts recognized in the income statement are included in the item “Personnel costs” (Note 31).

The contributions which are expected to be paid for pension funds during 2007 amount to Euros37,678 thousand.

- Employees’ leaving indemnity (TFR)

The changes during the year in employees’ leaving indemnity are as follows:


Beginning balance 100,099 136,014Discontinued operations - (32,089)Change in the scope of consolidation 2,497 (348)Movements through the income statement 14,979 16,576Actuarial (gains)/losses recognized in equity (4,122) (6,090)Payments/advances (17,040) (14,093)Transfers 329 196Other 82 (67)Closing balance 96,824 100,099

156


Beginning January 1, 2007, the Italian Finance Bill and the relative decrees implementing it introducedchanges regarding employees’ leaving indemnity which include allowing the employee to choose thedestination of his/her indemnity that is accruing. In particular, the employee can choose to direct thenew flows of the indemnity to pre-chosen pension schemes or to keep them with the company (inwhich case, the company will pay the TFR contributions to a treasury account set up at INPS). At thepresent time, the uncertainty surrounding the interpretation of the recently enacted law, the variouspossible interpretations of the qualification under IAS 19 of the TFR accruing and the resultingchanges in the actuarial calculations of the indemnity already accrued, as well as the impossibility ofestimating what destinations will be chosen by the employee (the individual employees have untilJune 30 to make their decisions) would render it premature to offer any assumptions on the actuarialchange in the calculation of the indemnity accrued at December 31, 2006.

- Medical care plans

The composition of medical care plans is as follows:

(in thousands of euros)USA

Liability in the balance sheet at December 31, 2006 28,362Liability in the balance sheet at December 31, 2005 33,386

The medical care plan existing in the United States covers white-collars and blue-collars, in serviceand retired.The plan is structured according to “pre-medicare” and “post-medicare”, with the latter referring toparticipants over the age of 65.Contributions are paid in both by the employer and the employee.

The changes during the year in the liabilities recognized in the financial statements for medical careplans are the following:


Beginning balance 33,386 46,528Discontinued operations - (18,216)Exchange differences (3,552) 4,478Movements through the income statement 1,535 1,725Actuarial (gains)/losses recognized in equity (995) 2,071Benefits paid (1,906) (3,200)Other (106) -Closing balance 28,362 33,386

The effect of a one percentage point increase or decrease in the estimated rates for the costs ofmedical care is as follows:

(in thousands of euros)1% increase 1% decrease

12/31/2006 12/31/2005 12/31/2006 12/31/2005- Effect on current service cost and interest cost 65 50 (63) (45)- Effect on liabilities recognized in the balance sheet 1,126 835 (1,068) (763)

The amounts recognized in the income statement relating to medical care plans are as follows:


Current service costs 8 60Interest cost 1,527 1,665

1,535 1,725

The amounts recognized in the income statement are included in the item “Personnel costs” (Note 31).

157


- Other information

Actuarial gains referring to 2006 recognized directly in equity amount to Euros 51,081 thousand(actuarial losses of Euros 69,123 thousand at December 31, 2005). The cumulative amount atDecember 31, 2006, equal to a net loss of Euros 65,286 thousand, is made up as follows:

(in thousands of euros)Cumulative amount at 12/31/2005 (116,468)Exchange differences 101year 2006 51,081 Cumulative amount at 12/31/2006 (65,286)

The cumulative amount at December 31, 2005 was composed as follows:

(in thousands of euros)Cumulative amount at 12/31/2004 (52,978)Exchange differences (2,468)Discontinued operations 8,101 Year 2005 (69,123)Cumulative amount at 12/31/2005 (116,468)

The breakdown of the cumulative amount at December 31, 2006 by country is as follows:

(in thousands of euros)cumulative amount at December 31, 2006

Italy Germany USA UK TotalPension funds - (4,845) (11,749) (56,706) (73,300)Medical care plans - - (1,912) - (1,912)Employees’ leaving indemnity 9,926 - - - 9,926Total actuarial gains/(losses)recognized in equity 9,926 (4,845) (13,661) (56,706) (65,286)

The breakdown of the cumulative amount at December 31, 2005 by country is as follows:

(in thousands of euros)cumulative amount at December 31, 2005

Italy Germany USA UK TotalPension funds - (7,999) (16,505) (94,811) (119,314)Medical care plans - - (3,244) - (3,244)Employees’ leaving indemnity 6,090 - - - 6,090Total actuarial gains/(losses)recognized in equity 6,090 (7,999) (19,749) (94,811) (116,468)

The main actuarial assumptions used at December 31, 2006 and also to determine the estimated costfor the year 2007 are as follows:

Italy Germany UK USADiscount rate 4.50% 4.50% 5.10% 5.75%Inflation rate 2.0% 2.0% 2.80% - Expected return on plan assets - - 7.31% 7.5%Expected remuneration increase rate 2% - 4.3% 2.50% 2.80% - Medical care cost trend rate - initial - -- - 9.0%Medical care cost trend rate - final - - - 4.5%

158


The main actuarial assumptions used at December 31, 2005 and also to determine the estimated costfor the year 2006 were as follows:

Italy Germany UK USADiscount rate 4.0% 4.25% 4.75% 5.50%Inflation rate 2.0% 2.0% 2.50% - Expected return on plan assets - - 6.85% 7.0%Expected remuneration increase rate 3.2% 2.50% 2.50% - Medical care cost trend rate - initial - - - 9.5%Medical care cost trend rate - final - - - 4.5%

The adjustments based on past experience made to defined benefit plans are the following:


Adjustments to plan liabilities (7,527) 46,038 Adjustments to plan assets (32,733) (75,756)

The adjustments to liabilities represent the change in the actuarial liability that is not generated bychanges in the actuarial assumptions. These typically include changes in the demographic andremuneration structure. Experience does not include the changes in the plan regulations (“pastservice cost”).The adjustments to assets represent the difference between the effective return of the assets and theexpected return at the start of the year.

24. BORROWINGS FROM BANKS AND OTHER FINANCIAL INSTITUTIONS

The analysis of borrowings from banks and other financial institutions is as follows:(in thousands of euros)

December 31, 2006 December 31, 2005Total Non-current Current Total Non-current Current

Bonds 1,150,000 650,000 500,000 1,150,000 1,150,000 - Borrowings from banks 1,668,780 658,881 1,009,899 836,109 311,999 524,110 Borrowing from other financialinstitutions 31,757 31,116 641 53,947 50,117 3,830 Finance lease payables 39,223 35,949 3,274 41,653 38,045 3,608 Financial accrued liabilitiesand deferred income 40,669 - 40,669 44,559 - 44,559 Other financial payables 9,260 1,481 7,779 24,606 351 24,255

2,939,689 1,377,427 1,562,262 2,150,874 1,550,512 600,362

These liabilities are secured by real guarantees (liens and mortgages) for Euros 73,262 thousand.

For the current payables and the other non-current payables (excluding bonds), the carrying amountapproximates fair value.The amount due within one year, totaling Euros 1,562,262 thousand, includes the current portion oflong-term financial payables of Euros 623,300 thousand (Euros 382,046 thousand at December 31,2005).

At December 31, 2006, the breakdown of payables by interest rate is as follows:(in thousands of euros)

Fixed rate Floating rate TOTALCurrent 771,979 790,283 1,562,262Non-current 915,563 461,864 1,377,427Total 1,687,542 57% 1,252,147 43% 2,939,689

159


At December 31, 2005, the situation was as follows:

(in thousands of euros)Fixed rate Floating rate TOTAL

Current 109,618 490,744 600,362 Non-current 1,360,047 190,465 1,550,512 Total 1,469,665 68% 681,209 32% 2,150,874

The maturities of non-current payables can be summarized as follows:


between 1 and 2 years 543,902 612,950 between 2 and 5 years 601,150 889,525 beyond 5 years 232,375 48,037

1,377,427 1,550,512

The maturities of non-current payables can be summarized as follows:

(in millions of euros)Current Non-current TOTAL

EUR 1,487 1,313 2,800 USD 37 35 72 BRL (Brazil Real) 7 29 36 CNY (Chinese Renminbi) 29 - 29 Other currencies 2 - 2

1,562 1,377 2,939

At December 31, 2005, the composition was as follows:

(in millions of euros)Current Non-current TOTAL

EUR 522 1,464 1,986 USD 3 54 57 BRL (Brazil Real) 38 33 71 CNY (Chinese Renminbi) 37 - 37

600 1,551 2,151

With regard to financial covenants on the credit lines agreed and used, the following should be noted:

• on the Syndicated Line (granted to Pirelli & C. Real Estate S.p.A.), in which 18 banks participatefor a total of Euros 450 million, Pirelli & C. Real Estate S.p.A. is obliged not to exceed a certainvalue in the ratio of the adjusted financial position (expressed gross of the loans made byshareholders to the companies in which minority interests are held) to the operating resultincluding earnings (losses) and financial income from investment holdings;

• on the credit line granted by Banca Monte dei Paschi di Siena to the Pirelli Real Estate Group,Pirelli & C. Real Estate S.p.A. is obliged not to exceed a certain value in the ratio of the adjustedfinancial position (expressed gross of the loans made by shareholders to the companies in whichminority interests are held) to equity.

At December 31, 2006, both of these covenants were within the limits.On the Syndicated Line, there is also a negative pledge clause on the shares and the receivables ofthe services companies.The other financial payables in existence are not covered by financial covenants or clauses whichcould cause the early repayment of the loans due to events other than insolvency.

160


There are no significant negative pledge clauses.The bonds – current portion (Euros 500,000 thousand) refer to bonds issued in 2002 by the subsidiaryPirelli Finance (Luxembourg) S.A., maturing April 4, 2007, paying interest at 6.5 percent.The non-current portion refers to:

– 1998-2008 bonds of Euros 500,000 thousand, issued by Pirelli & C. S.p.A. on October 21, 1998,paying interest at 4.875 percent and repayable in a one-off payment on October 21, 2008;

– bonds of Euros 150,000 thousand issued by Pirelli & C. S.p.A. in 1999, paying interest at 5.125percent, maturing on April 7, 2009.

These bonds do not contain either financial covenants or clauses which could cause the earlyrepayment of the bonds due to events other than insolvency.

With regard to negative pledge clauses, there is a commitment on these bonds requiring that realguarantees are not to be provided on relevant debt (bonds and similar securities destined for listing)with the exception for real guarantees on existing debt and, in the first case, for relevant debt, belowthe floor of Euros 100 million.

The fair value of the bonds compared to the carrying amount is as follows:

(in thousands of euros)Carrying amount Fair value

12/31/2006 12/31/2005 12/31/2006 12/31/2005Pirelli & C. S.p.A. 1998-2008 500,000 500,000 501,010 512,300 Pirelli & C. S.p.A. 1999-2009 150,000 150,000 150,351 153,503 Pirelli Finance (Luxembourg) S.A. 2002-2007 500,000 500,000 502,685 511,825

1,150,000 1,150,000 1,154,046 1,177,628

Fair value corresponds to market prices, respectively, at December 31, 2006 and at December 31,2005.

Financial accruals mainly include the amount of interest accrued but not yet paid on bonds(Euros 34,604 thousand).

As for financial lease payables, reference should be made to Note 7.1 “Leasing”.

25. TRADE PAYABLES

The analysis of trade payables is as follows:

(in thousands of euros)December 31, 2006 December 31, 2005

Total Non-current Current Total Non-current CurrentAssociates and joint ventures 8,366 - 8,366 11,390 - 11,390 Others 991,137 - 991,137 902,476 - 902,476 Notes payable 102,953 - 102,953 104,398 - 104,398

1,102,456 - 1,102,456 1,018,264 - 1,018,264

161


26. OTHER PAYABLES

The analysis of other payables is as follows:

(in thousands of euros)December 31, 2006 December 31, 2005

Total Non-current Current Total Non-current CurrentAssociates and joint ventures 3,263 - 3,263 315 - 315 Trade and other accrued liabilitiesand deferred income 150,002 38,932 111,070 143,177 10,955 132,222 Tax payables 92,955 3,409 89,546 75,349 8,572 66,777 Payables to employees 123,059 73 122,986 120,258 50 120,208 Payables to social security agencies 48,148 2,064 46,084 43,364 1,481 41,883 Payables for stock options 1,609 - 1,609 11,743 - 11,743 Dividends payable 2,196 - 2,196 905 - 905 Advances from customers 3,796 7 3,789 4,410 29 4,381 Other payables 244,754 112,401 132,353 500,562 40,681 459,881

669,782 156,886 512,896 900,083 61,768 838,315

Current accrued liabilities and deferred income include:– revenues (Euros 10,000 thousand) relating to the following year in respect of the use of the Pirelli

brand by the Prysmian group. This conforms to the terms of the agreement, executed on July 28,2005, between Pirelli & C. S.p.A. and Goldman Sachs Capital Partner for the sale to the latter ofPirelli’s Energy and Telecom Cables and Systems businesses;

– Euros 19,112 thousand referring to deferred gains relating to transactions mainly in respect of thesale of properties for the portion that has not yet been realized with third parties.

Non-current accrued liabilities primarily include Euros 33,300 thousand related to commissionswhich will be paid to the financial institutions which took part in the private placement of the 38.9percent interest of Pirelli Tyre S.p.A., up to the IPO.

The other current payables include Euros 64,581 thousand relating to the real estate sector mainlyfor down-payments made by property buyers on contracts that have not yet been executed (Euros16,358 thousand), payables for the acquisition of investments (Euros 10,888 thousand) and payablesfor non-performing loans (Euros 8,570 thousand).

The other non-current payables include Euros 79,013 thousand mainly related to the real estatesector mainly for the purchase of Class E and DPP junior notes on a non-performing loan portfolio ofthe former Banco di Sicilia by Pirelli & C. Real Estate S.p.A. (Euros 78,489 thousand).

27. FINANCIAL INSTRUMENTS

“Financial instruments”, included in current assets and current and non-current liabilities, comprisethe measurement at fair value of forward currency purchases and sales in place at December 31,2006. These are derivative transactions which, although used for hedging purposes, are notdesignated as such under IFRS. The fair value is determined by using the forward exchange rate atthe balance sheet date.

At December 31, 2005, “Financial instruments – current liabilities” comprised the measurement at fairvalue of the put options granted to the shareholders banks of Olimpia (Banca Intesa S.p.A. andUniCredit Italiano S.p.A.) under the shareholders’ agreements for Euros 233,000 thousand. This itemwas written off after the right of withdrawal communicated by the banks in March 2006 was

162


exercised and that was perfected on October 4, 2006 with the purchase of the Olimpia S.p.A. sharesby Pirelli & C. S.p.A. previously held by the banks.

At December 31, 2005, “Financial instruments – current assets” included Euros 31,843 thousandrelated to the measurement at fair value of the derivatives on Telecom Italia S.p.A. shares held by thesubsidiary Pirelli Finance (Luxembourg) S.A , which ended during the course of 2006.

28. COMMITMENTS AND CONTINGENCIES

Personal guarantees

Sureties were provided to guarantee loans made by credit institutions to associates and jointventures for a total of Euros 38,929 thousand consisting of the shares of the associates and jointventures pledged for an amount of Euros 44,853 thousand.Various sureties were provided by banking institutions and insurance companies to third parties andin the interests of Pirelli & C. Real Estate S.p.A. to fulfill contractual obligations of the Pirelli & C.Real Estate S.p.A. Group for a total of Euros 221,314 thousand.

Commitments for purchases of properties

Commitments for the purchase of properties refer to:• the commitment undertaken by Pirelli & C. Real Estate S.p.A. to purchase certain buildings that

remained unsold by Imser 60 S.r.l., for a maximum amount of Euros 320,000 thousand.The purchase price of these buildings is established by contract at about 20 percent of their marketvalue. This option may be exercised by the counterpart up to May 31, 2022;

• the commitment undertaken by Pirelli & C. Real Estate Agency S.p.A. with Pirelli & C. Real EstateOpportunities Società di Gestione del Risparmio S.p.A. to purchase a building located in Segrate atthe price of Euros 9,100 thousand if the building is not sold by December 22, 2007;

• the commitment undertaken by Resident Baltic GmbH for the purchase of buildings located inRostock (Germany) for an amount of Euros 13,200 thousand and by Resident Sachsen GmbH forthe purchase of a building located in Germany for an amount of Euros 500 thousand.

Commitments for purchases of property, plant and equipment

Commitments for the purchase of property, plant and equipment refer to the Tyres Sector and totalEuros 91.5 million mainly related to the companies in Brazil, Romania, China and Germany.

Commitments for purchases of investments / shares of funds

These refer to:• the put option granted to Edizione Finance International S.A./Edizione Holding S.p.A. (“Edizione”),

under the shareholders’ agreement signed on August 7, 2001, and subsequently amended.This put option can be exercised in the case of a (I) deadlock situation among the shareholders,(II) withdrawal on the part of Pirelli & C. S.p.A. from the shareholders’ agreements and (III) theoccurrence of a substantial change in the controlling structure of Pirelli & C. S.p.A., by which ismeant the exercise by parties other than those currently holding the determining power tonominate the majority of the members of the management board, with a consequent potentialmodification of the strategic guidelines.The exercise price of the put option is equal, respectively, under assumption (I) to the price equalto the value of the economic capital of Olimpia increased by a premium (the “Price”), in the case of(II) to the Price increased by an amount equal to 50 percent of the Price and in the case of (III) tothe Price increased by an amount equal to 200 percent of the Price. In this case, however, there isno provision for a Floor or Cap.;

163


• the irrevocable put option in favor of Marzotto S.p.A. for the transfer to Pirelli & C. Real EstateS.p.A. of the entire residual receivable for principal and interest due, at the date of December 31,2006, by the same Marzotto S.p.A. from the joint venture Aree Urbane S.r.l. for amounts shown asshareholder loans. Subject to the exercise of that option, a call option in favor of Pirelli & C. RealEstate S.p.A. can be exercised for the purchase of the investment held by Marzotto S.p.A. in AreeUrbane S.r.l. (32.5 percent).

• the commitment undertaken by Pirelli & C. Real Estate Società di Gestione del Risparmio S.p.A. tosubscribe shares of the closed-end real estate Fund “Fondo Abitare Sociale 1 – Fondo ComuneChiuso di Investimento Immobiliare Etico Riservato ad Investitori Qualificati”, for a total amount ofEuros 2,422 thousand.

Other guarantees

Other guarantees refer to:

• income guarantees provided to third parties on the sale of buildings for commercial use for Euros2,107 thousand;

• guarantees provided under securitization transactions conducted by vehicle companies for thecorrect and precise fulfillment of payment obligations for a total of Euros 61,435 thousand;

• guarantees provided under property purchase transactions effected by joint ventures for thefulfillment of their payment obligations of Euros 5,250 thousand.

In addition, Pirelli & C. Real Estate S.p.A. has a commitment to cover its proportionate share of anynegative difference between the flows from rental income and interest expense due to the lenderbanks by Tiglio I S.r.l. on their credit lines expiring in 2009. At the moment, on the basis of availableinformation, the projected revenue flows are higher than the estimated interest expense.

29. REVENUES FROM SALES AND SERVICES

Revenues from sales and services can be analyzed as follows:


Revenues from sales of products 4,244,589 3,967,530Revenues from services 590,657 566,429Revenues on construction contracts 5,978 11,710

4,841,224 4,545,669

30. OTHER INCOME

“Other income” amounts to Euros 292,763 thousand compared to Euros 283,612 thousand in 2005and includes rent income, commissions, royalties, compensation, insurance refunds and other minoritems.In 2006 royalties paid by other companies for the use of the Pirelli brand (Euros 25,891 thousand).In 2005, this item included royalties of Euros 21,116 thousand for the use of Pirelli intellectualproperties by the Energy and Telecom Cables and Systems companies sold on July 28, 2005(7.4 percent of the total), which qualify as nonrecurring events.

164


31. PERSONNEL COSTS

Personnel costs consist of the following:


Salaries and wages 809,982 767,302Stock option costs 6,069 7,247Social security costs 185,600 183,605Leaving indemnity and similar costs (*) 38,185 33,379Defined contribution pension fund costs 8,296 7,918Defined benefit pension fund costs 2,589 7,255 Defined benefit medical care plan costs 1,535 1,725 Long-service bonus costs 560 2,478 Defined contribution medical care plan costs 17,534 13,110 Other costs 5,421 5,861

1,075,771 1,029,880* Including italian and foreign company

With regard to the amounts relating to employees’ leaving indemnity, pension funds and medical caredefined benefit plans, reference should be made to “Employee benefit obligations” (Note 23).

32. AMORTIZATION, DEPRECIATION AND IMPAIRMENTS

Amortization, depreciation and impairments are as follows:


Amortization of intangible assets 11,263 15,640Depreciation of property, plant and equipment 201,428 197,038Impairment of property, plant and equipment/intangible assets 2,637 3,026

215,328 215,704

33. OTHER EXPENSES

“Other expenses” include the following:


Receivables writedown 13,620 9,808Other accruals 32,137 36,744Operating lease payments 7,494 6,403Rent and hires 61,568 56,095Software and information services expenses 37,036 41,114Consulting fees 116,422 146,900Insurance 28,912 28,918Maintenance 94,032 90,352Selling expenses 270,367 255,858Cleaning expenses 42,905 34,806Contractual work expenses 39,858 32,138Traveling expenses 42,654 38,322Advertising expenses 144,780 145,270Utilities and power 157,153 131,586Other 595,006 558,277

1,683,944 1,612,591

165


The balance in 2006 includes Euros 13,200 thousand (0.8 percent of the total) relating to the costsincurred for the Pirelli Tyre S.p.A. IPO, which qualifies as a nonrecurring event, included underconsulting fees, advertising expenses and other.The balance in 2005 included Euros 20,998 thousand (1.3 percent of the total) relating to expensesincurred for the sale of the Energy and Telecom Cables and Systems operations, which qualify asnonrecurring events, included in consulting fees.

Research expenses went from Euros 174 million in 2005 (3.8 percent of sales) to Euros 171 million in2006 (3.5 percent of sales). They are entirely expensed to income statement. There are nodevelopment expenditures which meet the conditions for capitalization under IFRS.

34. FINANCIAL INCOME

Financial income includes the following:


Interest 76,460 68,736Other financial income 32,389 15,465Gains on exchange 145,576 142,961Gains on disposal of available-for-sale financial assets 218,563 9,443Gains on disposal of investments in subsidiaries 416,400 -Gains on disposal of securities held for trading 7,989 11,705

897,377 248,310

Other financial income includes Euros 13,000 thousand relating to derivatives on Telecom Italia S.p.A.shares following the change of the underlying hedged item from bonds to shares.

Gains on exchange include the adjustment of open items at the balance sheet date expressed incurrencies other than the functional currency and the gains realized on closed positions.

Gains on the disposal of available-for-sale financial assets mainly include Euros 215,200 for the saleof the investment in Capitalia S.p.A..

The gains on the disposal of investments in subsidiaries, equal to Euros 416,400 thousand, relate tothe sale of a 38.9 percent interest in the capital of Pirelli Tyre S.p.A. for consideration of Euros 740million, equal to an equity value for the entire company of approximately Euros 1.9 billion.

The above gains (for a total of Euros 631,600 thousand equal to 70.4 percent of “financial income”)qualify as nonrecurring events.

35. FINANCIAL EXPENSES

Financial expenses include the following:


Bank interest 151,288 126,466Other financial expenses 78,403 39,248Losses on exchange 129,700 146,416Losses on disposal of available-for-sale financial assets 5,732 1,552

365,123 313,682

166


Other financial expenses mainly include Euros 27,351 thousand relating to the equity swaptransactions on Telecom Italia S.p.A. shares (held by the subsidiary Pirelli Finance Luxembourg S.A.)which ended during the course of the year with a payment of Euros 10,072 thousand, Euros 7,465thousand relating to losses on other derivatives on Telecom Italia S.p.A. shares and also bankcommissions, listing rights and other financial expenses.

Losses on exchange include the adjustment of open items at the balance sheet date expressed incurrencies other than the functional currency and losses realized on closed positions.

36. DIVIDENDS

Dividends primarily refer to those received from Telecom Italia S.p.A. (Euros 26,344 thousand), fromCapitalia S.p.A. (Euros 9,938 thousand), from RCS MediaGroup S.p.A. (Euros 3,875 thousand), fromMediobanca S.p.A. (Euros 8,702 thousand), from Consortium S.r.l. (Euros 11,162 thousand) and fromFin.Priv. S.r.l. (Euros 1,132 thousand).

37. VALUATION OF FINANCIAL ASSETS

The valuation of financial assets includes:


Impairment loss of available-for-sale financial assets (13,378) (22,391)Measurement of securities held for trading at fair value 2,814 15,923Measurement of currency derivatives at fair value (35,201) (19,640)Measurement of other derivatives at fair value (8,629) (63,961)

(54,394) (90,069)

The “impairment loss of available-for-sale financial assets” mainly includes the writedown of theinvestments in G.I.M. – Generale Industrie Metallurgiche S.p.A. (Euros 1,244 thousand), ConsortiumS.r.l. (Euros 4,532 thousand), Euroqube S.A. (Euros 2,181 thousand), Allopitc Inc. (Euros 1,000thousand), Stip Tunisi (Euros 1,206 thousand) and KG Deutsche Gasrubwerke GmbH (Euros 1,710thousand).

The “measurement of securities held for trading at fair value” refers to the fair value adjustment at year-end of listed securities classified in the financial statements as “securities held for trading” (Note 17).

The “measurement of currency derivatives at fair value” includes transactions for forward currencypurchases and sales. For open positions at year, the fair value is determined using the exchange rateat the balance sheet date.

The “measurement of other derivative instruments at fair value” includes Euros 7,899 thousandrelating to the negative fair value change in the call options on Telecom Italia shares, held by thesubsidiary Pirelli Finance (Luxembourg) S.A., and exercised in March 2006.

38. SHARE OF EARNINGS (LOSSES) OF ASSOCIATES AND JOINT VENTURES

The share of earnings (losses) of associates and joint ventures accounted for using the equity methodis a loss of Euros 1,836,242 thousand (earnings of Euros 251,366 thousand in 2005). The itemparticularly includes:

167


• the share of the loss of Olimpia S.p.A. for Euros 1,940,039 thousand (earnings of Euros 152,486thousand in 2005), mainly generated as a result of the writedown of the investment held in TelecomItalia S.p.A. for Euros 2,110,000 thousand (please refer to the specific paragraph relating toinvestments in associates and joint ventures – Note 10), which qualifies as a nonrecurring event;

• the earnings of the investments in the real estate sector accounted for using the equity method(Pirelli Real Estate Group) for Euros 101,570 thousand (Euros 98,787 thousand in 2005).

39. INCOME TAXES

Income taxes for the period are composed as follows:


current income taxes 125,460 122,745deferred income taxes 2,388 5,739

127,848 128,484

The reconciliation between theoretical and effective taxes is as follows:


Income before taxes (890,978) 477,538Share of earnings of associates and joint ventures 1,836,242 (251,366) Total taxable income 945,264 226,172Theoretical income taxes (310,044) (103,392)Main reasons for differences between theoretical and effective income taxes:Non-taxable income 288,359 139,653Non-deductible costs (88,735) (156,213)Utilization of tax loss carryforwards 27,483 16,860Unrecognized deferred taxes (18,763) (36,525)Other (26,149) 11,133Effective income taxes (127,848) (128,484)

The percentage of the effective tax charge of the Group for 2006 is lower than the 32.8 percenttheoretical tax charge of the Group given the presence of income components not subject to taxationmainly in reference to gains on the disposal of investments to third parties and the use of tax lossescarryforwards which had not been recognized as deferred tax assets. The figure also includes therecognition by Pirelli & C. S.p.A. of the tax effects generated by the option for national taxconsolidation.The theoretical tax charge of the Group is calculated by taking into account the nominal tax ratesin the countries in which the major companies of the Group operate, as indicated in the followingtable:

Europe: 2006 2005 North America: 2006 2005Italy 37.25% 37.25% USA 40% 40%Spain 35% 35% South America:Germany 38.34% 41.4% Argentina 35% 35%United Kingdom 30% 30% Brazil 34% 34%Turkey 20% 30% Venezuela 34% 34%Source : KPMG Corporate Tax Rate Survey 2006

168


40. INCOME (LOSS) FROM DISCONTINUED OPERATIONS

On July 28, 2005, the agreement was executed between Pirelli & C. S.p.A. and Goldman Sachs CapitalPartners for the purchase of Pirelli’s Energy and Telecom Cables and Systems activities by GoldmanSachs Capital Partners.The “income from discontinued operations” for 2005 included the income from discontinuedoperations for the six months ending June 30, 2005 (Euros 32,773 thousand) and the impact from thedisposal (Euros 17,123 thousand), for a total of Euros 49,896 thousand.

The “loss from discontinued operations” for the year 2006 of Euros 30,000 thousand refers to theadjustment of the accruals relating to the price adjustment envisaged by the contract and theguarantees provided.

41. EARNINGS (LOSS) PER SHARE

Basic earnings (loss) per share is calculated by dividing the income (loss) attributable to theequity holders of the company (adjusted for the minimum dividends due to savings shares) by theweighted average number of outstanding ordinary shares during the year, excluding ordinary treasuryshares.

2006 2005Income/(loss) from continuing operations for the year attributableto the equity holders of the company (1,137) 278Income/(loss) attributable to savings shares considering the extra 2%(except for 2006 in that the net result is a loss) * 29 (8)Income/(loss) from adjusted continuing operations for the year attributableto the equity holders of the company (1,108) 270

Weighted average number of outstanding ordinary shares (in thousands) 5,205,142 4,861,900

Basic earnings (loss) per ordinary share from continuing operations(in euros per thousand of shares) (212,87) 55,53

2006 2005Income/(loss) from discontinued operations for the year attributableto the equity holders of the company (30) 49Income/(loss) attributable to savings shares considering the extra 2%(except for 2006 in that the net result is a loss) * 1 (1)Income/(loss) from discontinued operations for the year attributableto the equity holders of the company (29) 48

Weighted average number of outstanding ordinary shares (in thousands) 5,205,142 4,861,900

Basic earnings (loss) per ordinary share from discontinued operations(in euros per thousand of shares) (5.57) 10.08* This right will be cumulative with that matured in the first year in which the company reports a profit.

169


Diluted earnings (loss) per share is calculated by adjusting the weighted average number ofoutstanding ordinary shares to assume conversion of all dilutive potential ordinary shares.The company has only one category of dilutive potential ordinary shares: stock options.Since the price to exercise the stock options is higher than market value, the stock options areassumed not to have been exercised.At December 31, 2005, the dilutive potential shares deriving from the exercise of outstandingwarrants had been considered.At December 31, 2006, there are no longer any warrants outstanding.

2006 2005Income/(loss) from continuing operations for the year attributableto the equity holders of the company (1.137) 278Income/(loss) attributable to savings shares considering the extra 2%(except for 2006 in that the net result is a loss) * 29 (8)Income/(loss) from adjusted continuing operations for the year attributableto the equity holders of the company (1.108) 270Weighted average number of outstanding ordinary shares (in thousands) 5.205.142 4.861.900Adjustment for the issue of warrants 18.963Adjusted weighted average number of outstanding ordinary shares (in thousands) 5.205.142 4.880.863Diluted earnings (loss) per ordinary share from continuing operations(in euros per thousand of shares) (212,87) 55,32

2006 2005Income/(loss) from discontinued operations for the year attributableto the equity holders of the company (30) 49Income/(loss) attributable to savings shares considering the extra 2%(except for 2006 in that the net result is a loss) 1 (1)Income/(loss) from discontinued operations for the year attributableto the equity holders of the company (29) 48Weighted average number of outstanding ordinary shares (in thousands) 5.205.142 4.861.900Adjustment for the issue of warrants 18.963Adjusted weighted average number of outstanding ordinary shares (in thousands) 5.205.142 4.880.863Diluted earnings (loss) per ordinary share from discontinued operations(in euros per thousand of shares) (5,57) 10,04* This right will be cumulative with that matured in the first year in which the company reports a profit.

42. DIVIDENDS PER SHARE

The company paid dividends of Euros 108,767 thousand on the ordinary shares (Euros 0.0210 pershare) and Euros 4,905 thousand on the savings shares (Euros 0.0364 per share).

43. HYPERINFLATION

The subsidiary with headquarters in Venezuela used inflation accounting to prepare its consolidatedfinancial statements at December 31, 2006. In accordance with Group accounting principles withregard to the criteria for starting and discontinuing use of inflation accounting, this company willcease to use inflation accounting starting from January 1, 2007.

The gains and losses on the net monetary position are recognized in the income statement under“Other expenses” (Note 33) for Euros 766 thousand (Euros 125 thousand in 2005) for the partrelating to the monetary adjustment relative to non-financial factors and under “Financial expenses”(Note 35) for Euros 1,936 thousand (Euros 2,899 thousand in 2005) for the part relative to themonetary adjustment relative to financial factors.

170


171

44. RELATED PARTY DISCLOSURES

Related party transactions, including intragroup transactions, are neither unusual nor exceptional butfall under the ordinary course of business of the companies of the Group. Such transactions, whennot concluded at standard conditions or dictated by specific laws, are in any case conducted at arm’slength.

The following table summarizes the balance sheet and income statement captions which includerelated party transactions and the relative percentage of the total:

(in millions of euros)Total in of which % of total Total in of which % of total

financial related financial relatedstatements 2006 parties statements 2005 parties

Balance sheet

Non-current assetsOther receivables 705.8 334.2 47.4% 538.8 262.3 48.7%

Current assetsTrade receivables 999.7 168.1 16.8% 943.4 190.1 20.1%Other receivables 356.2 11.9 3.3% 325.0 1.0 0.3%

Current liabilitiesBorrowings from banks and otherfinancial institutions 1,562.3 0.2 0.0% - - -Trade payables 1,102.5 25.1 2.3% 1,018.3 26.5 2.6%Other payables 512.9 3.4 0.7% 838.3 0.3 -Taxes payables 48.8 0.7 1.4% 42.2 - -

Income statementRevenues from sales and services 4,841.2 371.4 7.7% 4,545.7 405.2 8.9%Other income 292.8 104.1 35.6% 283.6 117.9 41.6%Personnel costs (1,075.8) (5.4) 0.5% (1,029.9) (8.1) 0.8%Other expenses (1,683.9) (111.1) 6.6% (1,612.6) (106.3) 6.6%Financial income 897.4 17.3 1.9% 248.3 13.2 5.3%Financial expenses (365.1) - - (313.7) (0.1) -Dividends 65.9 26.3 40.0% 26.7 10.1 37.8%

The income statement and balance sheet effect of transactions with related parties on theconsolidated financial statements of the Pirelli Group at December 31, 2006 are as follows,

Transactions with associates and joint ventures:(in millions of euros)

Revenues for goods and services 218 These mainly refer to the supply of services to associates andjoint ventures of Pirelli & C. Real Estate S.p.A..

Other expenses 10Financial income 17

Trade receivables 115 These mainly refer to receivables from associates and jointventures of Pirelli & C. Real Estate S.p.A..

Non-current other receivables 1

Non-current financial receivables 333 These mainly refer to receivables from associates and jointventures of Pirelli & C. Real EstateS.p.A..

Other current receivables 12 These mainly refer to receivables from associates and jointventures of Pirelli & C. Real Estate S.p.A..

Current trade payables 8 These mainly refer to payables to associates and joint ventures ofPirelli & C. Real Estate S.p.A..

Other current payables 3 These mainly refer to payables to associates and joint ventures ofPirelli & C. Real Estate S.p.A..


Transactions with parties related to Pirelli & C. S.p.A. through directors (Telecom Italia group,Camfin group and F.C. Internazionale Milano S.p.A.):

(in millions of euros)

Revenues for goods and services 153 These refer to services rendered by Pirelli & C. S.p.A., SharedService Center s.c.r.l. and Pirelli & C. Real Estate S.p.A. to theTelecom Italia group (Euros 147 million); services rendered byPirelli Ambiente Tecnologie S.p.A. to the Camfin group (Euros 2million) and services rendered to F.C. Internazionale Milano S.p.A.(Euros 4 million).

Other income 104 These refer to services rendered by Shared Service Center s.c.r.l.to the Telecom Italia group (Euros 104 million).

Other costs 89 These refer to telephone, computer and power services by theTelecom Italia group (Euros 32 million); the supply of natural gasby the Camfin Group (Euros 49 million) and costs for thesponsorship of F.C. Internazionale Milano S.p.A. (Euros 8 million).

Current trade receivables 54 These refer to receivables for the supply of the above services (tothe Telecom Italia group for Euros 51 million, to the Camfin groupEuros 1 million and F.C. Internazionale Milano S.p.A. Euros 2 million).

Current trade payables 16 These refer to payables for the supply of the above services (to theTelecom Italia group for Euros 3 million, the Camfin group Euros 11million and F.C. Internazionale Milano S.p.A. Euros 2 million).

Benefits to key executives

In 2006, the compensation to key executives, that is, those who have the power and theresponsibility, directly or indirectly, for the planning, direction and control of the activities of Pirelli& C. S.p.A., including executive and non-executive directors, amounts to Euros 17,201 thousand(Euros 18,648 thousand in 2005). The part relating to the payment of employee benefits was chargedto the income statement in “Personnel costs” (Note 31) for Euros 5,417 thousand, of which the partrelating to employees’ leaving indemnity totals Euros 361 thousand (Euros 8,149 thousand in 2005, ofwhich the part relating to employees’ leaving indemnity amounts to Euros 446 thousand). The partrelating to the compensation to directors was charged to the income statement in “Other expenses”(Note 33) for Euros 11,784 thousand (Euros 10,499 thousand in 2005).

45. SUBSEQUENT EVENTS

• On January 9, 2007, Pirelli & C. S.p.A. and Quattroduedue Holding B.V. (the controlling shareholder ofIntek S.p.A.), in view of the project for the merger of Gim S.p.A. in Intek S.p.A. and in execution of theprovisions established by the new codicil No. 1 among the members of the Gim S.p.A. Shareholders’Agreement, signed a put&call agreement relating to 14,923,526 Gim S.p.A. ordinary shares held byPirelli & C. S.p.A., equal to approximately 7.04 percent of Gim S.p.A. ordinary share capital.The understanding provides that, starting from the date the indicated merger comes into effect, Pirelli& C. S.p.A. and Quattroduedue Holding B.V. will have, respectively, the right to sell – up to the limits ofthe tender offer – and purchase the entire investment acquired by Pirelli & C. S.p.A. as a result of themerger for consideration of Euros 13.1 million.The agreement is subject to the merger becoming effective and can be carried out byQuattroduedue Holding B.V. in more than one tranche by and not after May 31, 2008. Subsequent tothat date, should Quattroduedue Holding B.V. not yet have exercised the option on the entireinvestment, Pirelli & C. S.p.A. will have the right to sell such shares to third parties, with thepossible payment of compensation by Quattroduedue Holding B.V. if there is a negative differencecompared to the agreed price.

• On January 17, 2007, Pirelli & C. S.p.A. announced that none of the parties in the Pirelli & C. S.p.A.shareholders’ agreement indicated the desire to withdraw from the pact within the contractuallyestablished expiration date of January 15, 2007. The pact will thus remain in effect, with the same

172


composition, until the new expiration date of April 15, 2010.• On January 22, 2007, Pirelli & C. Ambiente Eco Technology S.p.A., also active in the sector of

technologies for sustainable development, and LiqTech A/S, a Danish company which has operatedfor years in the sector of silicon carbide filters for the retrofit market, signed an agreement toconduct joint research into silicon carbide filters. The joint research project has the objective ofimproving the performance of silicon carbide filters. The results generated by the research will bejointly owned by the two companies but Pirelli will have the exclusive rights to exploit them inEurope, Russia and the former Soviet Republics, Brazil and China. Similarly, LiqTech will have theexclusive rights to exploit the results of the research in the U.S.A., Mexico, South Korea, India andJapan. Furthermore, under the agreement, LiqTech will support Pirelli & C. Ambiente EcoTechnology S.p.A. in the development of the production technology for mass-producing siliconcarbide anti-particulate filters which will first be used on diesel engines.The results generated by this development work will be the exclusive property of Pirelli & C.Ambiente Eco Technology S.p.A.and will be implemented in the factory which the company willstart to build in Romania in January 2007 to produce anti-particulate filters for the originalequipment market. As already mentioned, the factory will become operational in the second half of2008 and will have a production capacity of more than 1,300 tons of silicon carbide filters a year.

• On February 12, 2007, Pirelli Tyre S.p.A. announced that it had successfully concluded thesyndication of a five-year multicurrency revolving credit line announced to the market on January8, 2007. The contract was signed by the company with the mandated lead arrangers BNP Paribasand Banca Monte dei Paschi di Siena, and a pool of leading Italian and international banks(Akbank, Bank of America, Banca Carige, Banco do Brasil, Banca Popolare dell’Emilia Romagna,Banco Santander Central Hispano, ItauEuropa, Mizuho, Natixis and Royal Bank of Canada).In view of the high number of commitments, the initial amount of Euros 500 million was increasedto Euros 675 million.The loan bears interest at an initial rate equal to the Euribor + 40 basis points. The purpose of thetransaction is to allow Pirelli Tyre to improve its financial structure while at the same timeincreasing its flexibility.

• On February 27, 2007, the world council of the FIA accepted Pirelli’s offer to supply tyres for theWorld Rally Championship (WRC) over the three-year period 2008-2010, appreciating not only theproduct and Pirelli’s capacity for technological innovation, but also its aim to seek out andencourage young talent and to promote national championships. In particular, one of the reasonswhy the FIA chose Pirelli, is its century-long commitment to motor racing, and car rallies inparticular. Pirelli’s winning of the bid to supply the WRC was the second victory in the space of afew weeks. At the end of January, the Grand Am series, the most exciting championship forprototypes in the United States and one of the most popular in America, decided to adopt thePirelli PZero for the three-year period 2008-2010.

• On January 10, 2007, Pirelli RE, in execution of the binding agreement signed on October 9, 2006,purchased approximately 97 percent of Deutsche Grundvermogen AG (DGAG), one of the mostimportant real estate companies in Germany with offices in Hamburg and Kiel. The purchase price,subject to a price adjustment on the basis of the 2006 financial statements, was set atapproximately Euros 465 million for 100 percent of DGAG. As a result of additional purchases onJanuary 12, 2007, Pirelli RE increased its percentage ownership to more than 99 percent. Inkeeping with the Pirelli RE business model, DGAG will be transformed into a platform of realestate investments, asset management and services.By the end of 2007, DGAG’s residential portfolio worth approximately Euros 1,040 million will betransferred to the joint venture between Pirelli RE (35 percent) and the real estate investmentfunds of RREEF (65 percent), the division of Deutsche Bank which deals with real estateinvestments, while the retail and office portfolio worth approximately Euros 275 million will betransferred to the joint venture between Pirelli RE (30 percent) and the real estate investmentfunds of Morgan Stanley (MSREF) (70 percent). Other assets and the assets under management

173


and services will remain with Pirelli RE Deutschland.• On January 30, 2007, the board of directors of Pirelli Real Estate Società di Gestione del Risparmio

S.p.A. approved the management accounts of Tecla Fondo Uffici, Berenice Fondo Uffici and OlindaFondo Shops at December 31, 2006, confirming returns that were higher than the targets indicatedin the placement also for the year 2006.

• On February 12, 2007, land was purchased in the city of Portogruaro for approximately Euros 8million for the Eastgate Park project. This is the largest integrated industrial park in the east partof the northeast of the country on which construction began in the early months of 2006. OnFebruary 13, 2007, following the preliminary agreement signed on December 29, 2006, FondoSpazio Industriale also purchased two additional buildings for industrial use situated in Pordenoneand Belluno for a price of Euros 22 million.

46. OTHER INFORMATION

Compensation to directors and statutory auditors

Compensation to directors and statutory auditors of Pirelli & C. S.p.A. to carry out these functionsalso in other companies included in the scope of consolidation is as follows:


Directors 11,784 10,499 Statutory auditors 368 372

12,152 10,871

Employees

The average number of employees of the companies included in consolidation, by category, is thefollowing:


Executives and staff 7,579 7,328 Blue-collar 16,871 15,562 Temporary workers 3,713 3,313

28,163 26,203

Exchange rates

The main exchange rates used for consolidation purposes are as follows:

(valuta locale contro Euro)Year-end Change in Average Change in

12/31/2006 12/31/2005 % 2006 2005 %British pound 0.6715 0.6853 (2.01%) 0.6818 0.6838 (0.29%)Swiss franc 1.6069 1.5551 3.33% 1.5729 1.5482 1.60%Slovakian koruna 34.4350 37.8800 (9.09%) 37.2336 38.6031 (3.55%)American dollar 1.3170 1.1797 11.64% 1.2555 1.2444 0.90%Canadian dollar 1.5281 1.3725 11.34% 1.4236 1.5092 (5.67%)Brazilian real 2.8158 2.7613 1.97% 2.7334 3.0289 (9.76%)Venezuela bolivar 2,831.5500 2,536.3550 11.64% 2,699.3680 2,628.8349 2.68%Argentinean peso 4.0327 3.5769 12.74% 3.8601 3.6377 6.11%Australian dollar 1.6691 1.6109 3.61% 1.6670 1.6320 2.15%Chinese renminbi 10.2812 9.5181 8.02% 10.0089 10.1915 (1.79%)Singapore dollar 2.0202 1.9628 2.92% 1.9939 2.0707 (3.71%)Egyptian pound 7.5135 6.7567 11.20% 7.1991 7.1891 0.14%

174


Net financial position(non-GAAP measure)

The composition of the net financial position is as follows:

(in millions of euros)12/31/2006 of which 12/31/2005 of which

related parties related parties. Borrowings from banks and other financial institutions - current 1,522 556. Financial accrued liabilities and deferred income - current 60 62. Cash and cash equivalents (270) (300). Financial assets held for trading (119) (180). Financial receivables - current (27) (27). Financial accrued income and prepaid expenses - current (7) (12). Borrowings from banks and other financial

institutions - non-current 1,382 1,551Net financial debt 2,541 1,650. Financial receivables - non-current (553) (333) (468) (262). Financial accrued income and prepaid expenses - non-current (8) (5)Total net financial (liquidity)/debt position 1,980 1,177

The main nonrecurring events which had an impact on the net financial position are the following:• the purchase by Pirelli & C. S.p.A. of Olimpia S.p.A. shares from Hopa S.p.A., UniCredito Italiano

S.p.A. and Banca Intesa S.p.A. (Euros 1,534.8 million);• the sale of the entire investment in Capitalia S.p.A. (Euros 332.9 million);• the operation for the private placement of Pirelli Tyre S.p.A. (Euros 715.8 million).

175


List of investments

Companies consolidated line-by-line

Company Business Headquarters Share Capital Percentage Perc. Held byownership of

votingrights

EuropeAustriaECOI-Immobilien Gmbh Real Estate Vienna Euro 35,000 100.00% P&K Real Estate Gmbh Pirelli Gesellschaft mbH Tyre Vienna Euro 726,728 100.00% Pirelli Tyre (Europe) S.A.BelgiumPirelli Tyres Belux S.A. Tyre Brussels Euro 700,000 100.00% Pirelli Tyre (Europe) S.A.France

Pirelli & C. Ambiente Eco Tecnology S.p.A. (ex- Pirelli & C.

Gecam France S.a.S Enviroment Paris Euro 750,000 70.00% Ambiente Tecnologie S.p.A.)Pirelli Broadband Solutions

Pirelli Broadband Solutions France S.a.r.l. Enviroment Paris Euro 10,000 99.00% S.p.A.1.00% Maristel S.p.A.

Pneus Pirelli S.a.S Tyre Roissy en France Euro 1,515,858 100.00% Pirelli Tyre (Europe) S.A.GermanyAuster Real Estate (ex- aptus 226.Gmbh) Real Estate Hamburg Euro 25,000 100.00% Mistral Real Estate B.V.Deutsche Pirelli Reifen Holding Gmbh Financial Breuberg/Odenwald Euro 7,694,943 100.00% Pirelli Tyre Holland N.V.Drahtcord Saar Geschaeftsfuehrungs Gmbh Tyre Merzig Deut. Mark 60,000 50.00% Pirelli Deutschland GmbhDrahtcord Saar GmbH & Co. K.G. Tyre Merzig Deut. Mark30,000,000 50.00% Pirelli Deutschland Gmbh

Deutsche Pirelli Reifen HoldingDriver Fleet Solution Gmbh Tyre Breuberg/Odenwald Euro 26,000 100.00% GmbhEtesian Real Estate (ex- aptus 227.Gmbh) Real Estate Hamburg Euro 25,000 100.00% Mistral Real Estate B.V.Leste Real Estate (ex- aptus 228.Gmbh) Real Estate Hamburg Euro 25,000 100.00% Mistral Real Estate B.V.P&K Real Estate Gmbh Real Estate Berlin Euro 570,000 100.00% Pirelli & C. Real Estate S.p.A.

Deutsche Pirelli Reifen HoldingPirelli Deutschland Gmbh Tyre Breuberg/Odenwald Euro 26,334,100 100.00% GmbhPirelli & C. Real Estate Deutschland Gmbh(ex- Pirelli & C. Real Estate Germany Gmbh) Real Estate Berlin Euro 25,000 100.00% Jamesmail B.V.Pirelli & C. Real Estate Deutschland II Gmbh Real Estate Amburg Euro 25,000 100.00% Pirelli & C. Real Estate S.p.A.

Deutsche Pirelli Reifen HoldingPirelli Personal Service Gmbh Tyre Breuberg/Odenwald Euro 25,000 100.00% Gmbh

Deutsche Pirelli Reifen HoldingPK Grundstueckverwaltung Gmbh Tyre Hoechst/Odenwald Euro 26,000 100.00% Gmbh

Deutsche Pirelli Reifen HoldingPneumobil Gmbh Tyre Breuberg/Odenwald Euro 259,225 100.00% GmbhProjekt Pirelli & C. Real EstateNorthwind Gmbh & Co. K.G. Real Estate Hamburg Euro 1,000 94.90% Deutschland GmbhResident Baltic Gmbh (ex- gatus 251.Gmbh) Real Estate Berlin Euro 25,000 90.00% P&K Real Estate Gmbh Resident Berlin Zwei P&K Gmbh Real Estate Berlin Euro 100,000 94.90% P&K Real Estate Gmbh Resident Sachsen P&K Gmbh Real Estate Berlin Euro 25,000 85.00% P&K Real Estate Gmbh Tigotan Pirelli & C. Real EstateVermogenverwaltungsgesellschaft mbh Real Estate Amburg Euro 25,000 100.00% Deutschland GmbhTortuga Pirelli & C. Real EstateVermogenverwaltungsgesellschaft mbh Real Estate Amburg Euro 25,000 100.00% Deutschland GmbhGreeceElastika Pirelli S.A. Tyre Athens Euro 785,370 99.90% Pirelli Tyre (Europe) S.A.

Pirelli Tyre S.p.A (ex- Pirelli 0.10% Pneumatici S.p.A. )

Pirelli Hellas S.A. (in liquidation) Commercial Athens US $ 22,050,000 79.86% Pirelli Tyre Holding N.V.HungaryPirelli Hungary Tyre Trading and Services Ltd Tyre Budapest Hun. Forint 3,000,000 100.00% Pirelli Tyre (Europe) S.A.

176



votingrights

Ireland

Pirelli Reinsurance Company Ltd Reinsurance Dublin US $ 7,150,000 100.00% Pirelli Finance (Luxembourg) S.A.ItalyAcquario S.r.l. (in liquidation) Real Estate Genoa Euro 255,000 100.00% Pirelli & C. Real Estate S.p.A.Alfa S.r.l. Real Estate Milan Euro 2,600,000 100.00% Pirelli & C. Real Estate S.p.A. Asset Management NPL S.r.l. Real Estate Milan Euro 10,000 100.00% Pirelli & C. Real Estate S.p.A.Bernini Immobiliare S.r.l. Real Estate Milan Euro 500,000 100.00% Pirelli & C. Real Estate S.p.A.Beta S.r.l. Real Estate Milan Euro 26,000 100.00% Pirelli & C. Real Estate S.p.A.Botticino S.r.l. Real Estate Milan Euro 10,000 100.00% Pirelli & C. Real Estate S.p.A.

Pirelli & C. Real Estate AgencyCasaclick S.p.A. Real Estate Milan Euro 299,000 100.00% S.p.A.Centrale Immobiliare S.p.A. Real Estate Milan Euro 5,200,000 100.00% Pirelli & C. Real Estate S.p.A. Centro Servizi Amministrativi Pirelli S.r.l. Services Milan Euro 51,000 34.00% Pirelli & C. S.p.A.

Pirelli Tyre S.p.A (ex- Pirelli 33.00% Pneumatici S.p.A. )33.00% Pirelli & C. Real Estate S.p.A.

CFT Finanziaria S.p.A. Real Estate Florence Euro 10,010,000 100.00% Pirelli & C. Real Estate S.p.A.Pirelli & C. Real Estate Facility

Consorzio Stabile Pirelli RE Servizi Real Estate Milan Euro 200,000 100.00% Management S.p.A. Dolcetto Sei S.r.l. Real Estate Milan Euro 10,000 100.00% Pirelli & C. Real Estate S.p.A.

Pirelli Tyre S.p.A (ex- PirelliDriver Italia S.p.A. Commercial Milan Euro 350,000 73.07% Pneumatici S.p.A. )Edilnord Gestioni S.p.A. Real Estate Milan Euro 517,000 100.00% Pirelli & C. Real Estate S.p.A. Elle Uno Società Consortile a r.l. Real Estate Milan Euro 100,000 60.00% Edilnord Gestioni S.p.A.Erato Finance S.r.l. Real Estate Milan Euro 600,000 53.85% Pirelli & C. Real Estate S.p.A. Esedra S.r.l. Real Estate Milan Euro 2,376,234 100.00% Pirelli & C. Real Estate S.p.A.Geolidro S.p.A. Real Estate Naples Euro 3,099,096 100.00% Centrale Immobiliare S.p.A.Iniziative Immobiliari 3 S.r.l. Real Estate Milan Euro 10,000 100.00% Iniziative Immobiliari 3 B.V.Lambda S.r.l. Real Estate Milan Euro 578,760 100.00% Pirelli & C. Real Estate S.p.A.

Pirelli Broadband SolutionsMaristel S.p.A. Telecommunicat. Milan Euro 1,020,000 100.00% S.p.A.NewCo RE 1 S.r.l. Real Estate Milan Euro 30,000 100.00% Pirelli & C. Real Estate S.p.A. NewCo RE 2 S.r.l. Real Estate Milan Euro 10,000 100.00% Pirelli & C. Real Estate S.p.A. NewCo RE 4 S.r.l. Real Estate Milan Euro 10,000 100.00% Pirelli & C. Real Estate S.p.A. NewCo RE 5 S.r.l. Real Estate Milan Euro 40,000 100.00% Pirelli & C. Real Estate S.p.A. NewCo RE 6 S.r.l. Real Estate Milan Euro 40,000 100.00% Pirelli & C. Real Estate S.p.A. NewCo RE 7 S.r.l. Real Estate Milan Euro 40,000 100.00% Pirelli & C. Real Estate S.p.A. NewCo RE 8 S.r.l. Real Estate Milan Euro 40,000 100.00% Pirelli & C. Real Estate S.p.A. NewCo RE 9 S.r.l. Real Estate Milan Euro 40,000 100.00% Pirelli & C. Real Estate S.p.A.

Pirelli & C. Real Estate FacilityP.I.T. - Promozione Imprese e Territorio S.c.r.l. Real Estate Pozzuoli (Na) Euro 25,823 100.00% Management S.p.A. Parcheggi Bicocca S.r.l. Real Estate Milan Euro 1,500,000 75.00% Pirelli & C. Real Estate S.p.A.PBS S.C.a.r.l. Real Estate Milan Euro 100,000 60.00% Edilnord Gestioni S.p.A.

Pirelli & C. Ambiente S.p.A. (ex-Pirelli & C. Ambiente Eco Tecnology S.p.A. Pirelli & C. Ambiente Holding(ex- Pirelli & C. Ambiente Tecnologie S.p.A.) Enviroment Milan Euro 2,080,000 100.00% S.p.A.)

Pirelli & C. Ambiente S.p.A. (ex-Pirelli & C. Ambiente Renewable Energy S.p.A. Pirelli & C. Ambiente Holding(ex- Pirelli & C. Ambiente S.p.A.) Enviroment Milan Euro 3,060,000 100.00% S.p.A.)Pirelli & C. Ambiente S.p.A.(ex- Pirelli & C. Ambiente Holding S.p.A.) Enviroment Milan Euro 23,120,000 51.00% Pirelli & C. S.p.A.

Pirelli & C. Ambiente S.p.A. (ex-Pirelli & C. Ambiente Site Remediation S.p.A. Pirelli & C. Ambiente Holding(ex- Pirelli & C. Ambiente Bonifiche S.r.l.) Enviroment Milan Euro 155,700 100.00% S.p.A.)Pirelli & C. Opere Generali S.p.A. Real Estate Milan Euro 104,000 100.00% Pirelli & C. Real Estate S.p.A.

177



votingrights

Pirelli & C. Real Estate Agency S.p.A. Real Estate Milan Euro 832,000 100.00% Pirelli & C. Real Estate S.p.A. Pirelli & C. Real Estate Facility

Pirelli & C. Real Estate Energy S.p.A. Real Estate Milan Euro 120,000 100.00% Management S.p.A. Pirelli & C. Real Estate FacilityManagement S.p.A. Real Estate Milan Euro 5,561,000 100.00% Pirelli & C. Real Estate S.p.A. Pirelli & C. Real Estate FranchisingHolding S.r.l. Real Estate Milan Euro 120,000 70.00% Pirelli & C. Real Estate S.p.A. Pirelli & C. Real Estate Pirelli & C. Real EstateFranchising S.p.A Real Estate Milan Euro 500,000 100.00% Franchising Holding S.r.l. Pirelli & C. Real Estate Franchising Servizi Pirelli & C. Real EstateFinanziari S.r.l. Real Estate Milan Euro 10,000 100.00% Franchising Holding S.r.l. Pirelli & C. Real Estate OpportunitiesSocietà di Gestione del Risparmio S.p.A. Real Estate Milan Euro 1,000,000 100.00% Pirelli & C. Real Estate S.p.A. Pirelli & C. Real Estate S.p.A. Real Estate Milan Euro 21,274,678 50.30% Pirelli & C. S.p.A.

0.56% 0.00% Pirelli & C. Real Estate S.p.A. Pirelli & C. Real Estate PropertyManagement S.p.A. Real Estate Milan Euro 114,400 100.00% Pirelli & C. Real Estate S.p.A. Pirelli & C. Real Estate Società di Gestionedel Risparmio S.p.A. Real Estate Milan Euro 24,458,763 100.00% Pirelli & C. Real Estate S.p.A. Pirelli Broadband Solutions S.p.A. Telecommunicat. Milan Euro 10,120,000 100.00% Pirelli & C. S.p.A.Pirelli Cultura S.p.A. Sundry Milan Euro 1,000,000 100.00% Pirelli & C. S.p.A.

Research andPirelli Labs S.p.A. Development Milan Euro 10,000,000 100.00% Pirelli & C. S.p.A.Pirelli Nastri Tecnici S.p.A. (in liquidation) Sundry Milan Euro 384,642 100.00% Pirelli & C. S.p.A.Pirelli RE Credit Servicing S.p.A.(ex- Credit Servicing S.p.A.) Real Estate Milan Euro 1,809,500 100.00% Pirelli & C. Real Estate S.p.A.Pirelli Servizi Finanziari S.p.A. Financial Milan Euro 1,976,000 100.00% Pirelli & C. S.p.A.Pirelli Tyre S.p.A (ex- Pirelli Pneumatici S.p.A. ) Tyre Milan Euro 256,820,000 61.06% Pirelli & C. S.p.A.Polo Viaggi S.r.l. Travel Agency Milan Euro 46,800 100.00% Pirelli & C. S.p.A.Progetto Bicocca Università S.r.l. Real Estate Milan Euro 50,360 50.50% Pirelli & C. Real Estate S.p.A.Progetto Perugia S.r.l.(ex- Progetto Salute Bollate S.r.l.) Real Estate Milan Euro 100,000 100.00% Pirelli & C. Real Estate S.p.A. Progetto Vallata S.r.l. Real Estate Milan Euro 1,500,000 80.00% Pirelli & C. Real Estate S.p.A.

Pirelli & C. Real Estate Facility 9.00% Management S.p.A.

Servizi Amministrativi Real Estate S.p.A. Real Estate Milan Euro 520,000 100.00% Pirelli & C. Real Estate S.p.A. Servizi Aziendali Pirelli S.C.p.A. Services Milan Euro 104,000 95.00% Pirelli & C. S.p.A.

Pirelli Tyre S.p.A (ex- Pirelli 2.00% Pneumatici S.p.A. )1.00% Polo Viaggi S.r.l.2.00% Pirelli & C. Real Estate S.p.A.

Pirelli RE Credit Servicing S.p.A.Servizi Immobiliari Banche S.r.l. Immobiliare Milano Euro 10,100 100.00% (ex- Credit Servicing S.p.A.)

InformationShared Service Center S.c.r.l. Systems Milan Euro 1,756,612 50.00% Pirelli & C. S.p.A.Vindex S.r.l. Real Estate Brescia Euro 12,000 68.00% CFT Finanziaria S.p.A.

32.00% Pirelli & C. Real Estate S.p.A. LuxembourgPirelli Finance (Luxembourg) S.A. Financial Luxembourg Euro 270,228,168 100.00% Pirelli & C. S.p.A.PolandDriver Polska Sp.ZO.O. Tyre Warsaw Pol. Zloty 100,000 72.50% Pirelli Polska Sp.ZO.O.Pirelli Pekao Real Estate Sp.ZO.O. Real Estate Warsaw Pol. Zloty 35,430 75.00% Pirelli & C. Real Estate S.p.A. Pirelli Polska Sp.ZO.O. Tyre Warsaw Pol. Zloty 625,771 100.00% Pirelli Tyre (Europe) S.A.

178



votingrights

RomaniaS.C. Cord Romania S.R.L. Tyre Slatina Rom. Leu 24,990,100 80.00% Pirelli Tyre Holland N.V.S.C. Pirelli Tyres Romania S.R.L. Tyre Slatina Rom. Leu 77,169,800 95.00% Pirelli Tyre Holland N.V.


RussiaOOO Pirelli Tyre Russia Commercial Moscow Russian Rouble 950,000 95.00% Pirelli Tyre (Europe) S.A.

5.00% Pirelli Tyre Holland N.V.SlovakiaPirelli Slovakia S.R.O. Tyre Bratislava Slov. Koruna 200,000 100.00% Pirelli Tyre (Europe) S.A.SpainEuro Driver Car S.L. Tyre Barcelona Euro 690,000 25.00% Pirelli Neumaticos S.A.

26.00% Proneus S.L.Omnia Motor S.A. Tyre Barcelona Euro 1,502,530 100.00% Pirelli Neumaticos S.A.Pirelli Neumaticos S.A. Tyre Barcelona Euro 45,075,908 100.00% Pirelli Tyre Holland N.V.Proneus S.L. Tyre Barcelona Euro 3,005 51.00% Pirelli Neumaticos S.A.Tyre & Fleet S.L. Tyre Barcelona Euro 20,000 100.00% Pirelli Neumaticos S.A.SwedenPirelli Tyre Nordic A.B. Tyre Bromma Swed. Krona 950,000 100.00% Pirelli Tyre (Europe) S.A.SwitzerlandAgom S.A. Tyre Conthey Swiss Franc 50,000 80.00% Pirelli Tyre (Europe) S.A.Agom S.A. Bioggio Tyre Bioggio Swiss Franc 590,000 100.00% Pirelli Tyre (Europe) S.A.Pirelli Société de Services S.à r.l. Financial Basel Swiss Franc 50,000 100.00% Pirelli Tyre (Europe) S.A.Pirelli Société Générale S.A. Financial Basel Swiss Franc 28,000,000 100.00% Pirelli & C. S.p.A.Pirelli Tyre (Europe) S.A. Tyre Basel Swiss Franc 1,000,000 100.00% Pirelli Tyre Holland N.V.The NetherlandsIniziative immobiliari 3 B.V. Real Estate Amsterdam Euro 4,500,000 100.00% Pirelli & C. Real Estate S.p.A. Jamesmail B.V. Real Estate Amsterdam Euro 18,000 100.00% Pirelli & C. Real Estate S.p.A.Mistral Real Estate B.V. Real Estate Amsterdam Euro 18,000 100.00% Pirelli & C. Real Estate S.p.A.Pirelli China Tyre N.V. Tyre Heinenoord Euro 8,045,000 100.00% Pirelli Tyre Holland N.V.Pirelli RE Netherlands B.V. Real Estate Amsterdam Euro 21,000 100.00% Pirelli & C. Real Estate S.p.A.

HoldingPirelli Tyre Holding N.V. Company Heinenoord Euro 250,000,000 100.00% Pirelli & C. S.p.A.

Pirelli Tyre S.p.A (ex- PirelliPirelli Tyre Holland N.V. Tyre Heinenoord Euro 3,045,000 100.00% Pneumatici S.p.A. )Pirelli Tyres Nederland B.V. Tyre Heinenoord Euro 18,152 100.00% Pirelli Tyre (Europe) S.A.Sipir Finance N.V. Financial Heinenoord Euro 13,021,222 100.00% Pirelli & C. S.p.A.Solaia Real Estate B.V. Real Estate Amsterdam Euro 18,000 100.00% Pirelli & C. Real Estate S.p.A.TurkeyCelikord A.S. Tyre Istanbul Turk. Lira/mil. 29,000,000 50.733% Pirelli Tyre Holland N.V.


Turk-Pirelli Lastikleri A.S. Tyre Istanbul Turk. Lira/mil. 140,000,000 65.44% Pirelli Tyre Holland N.V.Pirelli Tyre S.p.A (ex- Pirelli

0.15% Pneumatici S.p.A. )United KingdomCentral Tyre Ltd Tyre London British Pound 100,000 100.00% Pirelli UK Tyres LtdCPK Auto Products Ltd Tyre London British Pound 10,000 100.00% Pirelli UK Tyres LtdCTC 1994 Ltd Tyre London British Pound 984 100.00% Central Tyre LtdPirelli International Ltd Financial London Euro 250,000,000 75.00% Pirelli UK Tyre Holding Ltd


Pirelli Tyres Ltd Tyre London British Pound 16,000,000 100.00% Pirelli UK Tyres LtdPirelli UK Finance Ltd Financial London British Pound 6,969,280 100.00% Pirelli UK Ltd “C”

179



votingrights

Pirelli UK Ltd “A” Tyre London British Pound 85,535,300 100.00% Pirelli Tyre Holding N.V.Finance Holding

Pirelli UK Ltd “C” Company London British Pound 11,625,978 100.00% Pirelli & C. S.p.A.Holding

Pirelli UK Tyre Holding Ltd Company London British Pound 96,331,000 100.00% Pirelli Tyre Holland N.V.Pirelli UK Tyres Ltd Tyre London British Pound 85,000,000 75.00% Pirelli UK Tyre Holding Ltd


North AmericaCanada

Frederic TownPirelli Tire Inc. Tyre (New Brunswick) Can. $ 6,000,000 100.00% Pirelli Tyre (Europe) S.A.U.S.A.

Pireli Broadband SolutionsPirelli Broadband Solutions North America Inc. Telecommunicat. Wilmington (Delaware) US $ 1 100.00% S.p.A.Pirelli North America Inc. Tyre Wilmington (Delaware) US $ 10 100.00% Pirelli Tyre Holland N.V. Pirelli Tire LLC Tyre Wilmington (Delaware) US $ 1 100.00% Pirelli North America Inc. “A”Central/South AmericaArgentinaPirelli Argentina de Mandatos S.A. Services Buenos Aires Arg. Peso 3,030,009 59.41% Pirelli & C. S.p.A.

40.59% Pirelli Société Générale S.A.Pirelli Neumaticos S.A.I.C. Tyre Buenos Aires Arg. Peso 101,325,176 95.00% Pirelli Tyre Holland N.V.

Pirelli Tyre S.p.A (ex- Pirelli 5.00% Pneumatici S.p.A.)

BrazilMuriaé Ltda Financial Santo Andrè Bra. Real 80,000,000 100.00% Pirelli Pneus S.A.Novacorp Consultora eServiços Corporativos Ltda Holding Company Santo Andrè Bra. Real 6,000 99.98% Pirelli S.A.Pirelli & C. Real Estate Ltda Real Estate Santo Andrè Bra. Real 2,000,000 100.00% Pirelli S.A.Pirelli Pneus Nordeste Ltda Tyre Feira de Santana Bra. Real 29,991,402 100.00% Pirelli Pneus S.A.

Pirelli Tyre S.p.A (ex- PirelliPirelli Pneus S.A. Tyre Feira de Santana Bra. Real 342,085,095 99.73%99.57% Pneumatici S.p.A. )Pirelli S.A. Financial Sao Paulo Bra. Real 49,189,271 100.00% Pirelli & C. S.p.A.Pneuac Comercial e Importadora Ltda Tyre Sao Paulo Bra. Real 12,913,526 100.00% Pirelli Pneus S.A.ChilePirelli Neumaticos Chile Limitada Tyre Santiago US $ 1,918,451 99.98% Pirelli Pneus S.A.

Pneuac Comercial e 0.02% Importadora Ltda

ColombiaPirelli de Colombia S.A. Tyre Santa Fe De Bogota Col. Peso/000 3,315,069 92.91% Pirelli Pneus S.A.

2.28% Pirelli de Venezuela C.A.1.60% Muriaè Ltda1.60% Pirelli Pneus Nordeste Ltda


MexicoPirelli Neumaticos de Mexico S.A. de C.V. Tyre Mexico City Mex. Peso 35,098,400 99.98% Pirelli Pneus S.A.


Servicios Pirelli Mexico S.A. de C.V. Tyre Mexico City Mex. Peso 50,000 99.00% Pirelli Pneus S.A.Pneuac Comercial e

1.00% Importadora LtdaVenezuelaPirelli de Venezuela C.A. Tyre Valencia Ven. Bolivar/000 20,062,679 96.22% Pirelli Tyre Holland N.V.

180



votingrights

AfricaEgypt

Pirelli Tyre S.p.A (ex- PirelliAlexandria Tire Company S.A.E. (*) Tyre Alexandria Egy. Pound 393,000,000 86.79% Pneumatici S.p.A. )

0.03% Pirelli Tyre (Europe) S.A.International Tire Company Ltd Tyre Alexandria Egy. Pound 50,000 99.80% Alexandria Tire Company S.A.E.South AfricaPirelli Tyre (Pty) Ltd Tyre Sandton S.A. Rand 1 100.00% Pirelli Tyre (Europe) S.A.OceaniaAustraliaPirelli Tyres Australia Pty Ltd Tyre Pymble - N.S.W. Aus. $ 150,000 100.00% Pirelli Tyre (Europe) S.A.New ZealandPirelli Tyres (NZ) Ltd Tyre Wellington N.Z. $ 100 100.00% Pirelli Tyres Australia Pty LtdAsiaChinaPirelli Tyre Co. Ltd China(ex- Yanzhou Evolution Tyre CO. Ltd) Tyre Yanzhou Renmimbi 800,000,000 60.00% Pirelli China Tyre N.V.JapanPirelli Japan Kabushiki Kaisha Tyre Tokyo Jap. Yen 2,700,000,000 100.00% Pirelli Tyre Holland N.V.SingaporePirelli Asia Pte Ltd Tyre Singapore Sing. $ 2 100.00% Pirelli Tyre (Europe) S.A.

(*) For IAS purposes, the percentage ownership is 89.1%

181


Investments accounted for by the equity method


votingrights

EuropeGermanyIndustriekraftwerk Breuberg Gmbh Cogeneration Hoechst/Odenwald Euro 1,533,876 26.00% Pirelli Deutschland GmbhResident Berlin 1 P&K Gmbh Real Estate Berlin Euro 125,000 40.00% P&K Real Estate Gmbh Tizian Wohnen 1 Gmbh Real Estate Berlin Euro 1,114,400 45.00% P&K Real Estate Gmbh Tizian Wohnen 2 Gmbh Real Estate Berlin Euro 347,450 45.00% P&K Real Estate Gmbh ItalyAgorà S.r.l. (in liquidation) Real Estate Milan Euro 10,000 40.00% Pirelli & C. Real Estate S.p.A.

Pirelli & C. Real Estate FacilityAltair Zander Italia S.r.l. Real Estate Milan Euro 100,000 50.00% Management S.p.A. Aree Urbane S.r.l. Real Estate Milan Euro 307,717 34.60% Pirelli & C. Real Estate S.p.A.

0.28% Pirelli & C. S.p.A.Cairoli Finance S.r.l. Real Estate Milan Euro 10,000 35.00% Pirelli & C. Real Estate S.p.A.Capitol Immobiliare S.r.l. Real Estate Milan Euro 10,000 33.00% Pirelli & C. Real Estate S.p.A. Castello S.r.l. Real Estate Milan Euro 1,170,000 49.10% Pirelli & C. Real Estate S.p.A.

Pirelli & C. Real Estate PropertyConsorzio ARP Real Estate Rome Euro 130,000 41.30% Management S.p.A.Continuum S.r.l. Real Estate Milan Euro 500,000 40.00% Pirelli & C. Real Estate S.p.A.Dixia S.r.l. Real Estate Milan Euro 2,500,000 30.00% Pirelli & C. Real Estate S.p.A.Dolcetto 8 S.r.l. Real Estate Milan Euro 10,000 50.00% Pirelli & C. Real Estate S.p.A. Domogest S.r.l. Real Estate Florence Euro 1,050,000 50.00% Centrale Immobiliare S.p.A.

Pirelli & C. Real Estate PropertyElle Dieci Società Consortile a.r.l. Real Estate Milan Euro 100,000 40.00% Management S.p.A.Elle Nove Società Consortile a.r.l. Real Estate Milan Euro 100,000 34.90% Edilnord Gestioni S.p.A.

Pirelli & C. Real Estate PropertyElle Tre Società Consortile a.r.l. Real Estate Milan Euro 100,000 40.00% Management S.p.A.Erice S.r.l. Real Estate Milan Euro 10,000 40.00% Pirelli & C. Real Estate S.p.A. Eurostazioni S.p.A. Holding Rome Euro 160,000,000 32.71% Pirelli & C. S.p.A.Fattoria Medicea S.r.l. Real Estate Prato (Florence) Euro 100,000 40.00% Pirelli & C. Real Estate S.p.A.

Pirelli & C. Real Estate AgencyG6 Advisor Real Estate Milan Euro 50,000 42.30% S.p.A.Galatea S.r.l. Real Estate Milan Euro 10,000 30.00% Pirelli & C. Real Estate S.p.A. Gestioni Immobiliari 2003 S.r.l. Real Estate Milan Euro 20,000 50.00% Pirelli & C. Real Estate S.p.A. Golfo Aranci S.p.A. - Società diTrasformazione Urbana Real Estate Milan Euro 1,000,000 43.80% Pirelli & C. Real Estate S.p.A.

Pirelli & C. Real Estate Facility 1.20% Management S.p.A. 5.00% Centrale Immobiliare S.p.A.

Pirelli & C. Ambiente RenewableEnergy S.p.A. (ex- Pirelli & C.

Idea Granda Società Consortile r.l. Enviroment Cuneo Euro 1,292,500 49.00% Ambiente S.p.A.) Immobiliare Prizia S.r.l. Real Estate Milan Euro 469,000 36.00% Pirelli & C. Real Estate S.p.A.Induxia S.r.l. Real Estate Milan Euro 836,300 18.00% Pirelli & C. Real Estate S.p.A.Iniziative Immobiliari S.r.l. Real Estate Gavirate (Va) Euro 5,000,000 49.46% Pirelli & C. Real Estate S.p.A.Le Case di Capalbio S.r.l. Real Estate Milan Euro 10,000 20.00% Pirelli & C. Real Estate S.p.A. Localto ReoCo S.r.l. Real Estate Milan Euro 10,000 35.00% Pirelli & C. Real Estate S.p.A.

Pirelli & C. Real Estate FacilityMalaspina Energy S.c.a.r.l. Real Estate Milan Euro 100,000 50.00% Management S.p.A. Maro S.r.l. (ex- M.S.M.C. Immobiare 3 S.r.l.) Real Estate Milan Euro 20,000 25.00% Pirelli & C. Real Estate S.p.A.

182



votingrights

Masaccio S.r.l. Real Estate Milan Euro 100,000 40.00% Pirelli & C. Real Estate S.p.A. Pirelli & C. Real Estate Facility

MP Facility S.p.A. Real Estate Milan Euro 1,000,000 50.00% Management S.p.A. Holding

Olimpia S.p.A. Company Milan Euro 4,630,233,510 80.00% Pirelli & C. S.p.A.Orione Immobiliare Prima S.p.A. Real Estate Milan Euro 104,000 40.10% Pirelli & C. Real Estate S.p.A.Perseo S.r.l. Services Milan Euro 20,000 50.00% Pirelli & C. S.p.A.Progetto Bicocca la Piazza S.r.l. Real Estate Milan Euro 3,151,800 26.00% Pirelli & C. Real Estate S.p.A.Progetto Corsico S.r.l. Real Estate Milan Euro 100,000 49.00% Pirelli & C. Real Estate S.p.A.Progetto Fontana S.r.l. Real Estate Milan Euro 10,000 23.00% Pirelli & C. Real Estate S.p.A.Progetto Gioberti S.r.l. Real Estate Milan Euro 100,000 50.00% Pirelli & C. Real Estate S.p.A.Progetto Lainate S.r.l. Real Estate Milan Euro 25,500 25.00% Pirelli & C. Real Estate S.p.A.

Consorzio Stabile Pirelli REProgetto Nuovo Sant'Anna S.r.l. Real Estate Milan Euro 3,000,000 49.50% ServiziQuadrifoglio Milano S.p.A. Real Estate Rome Euro 11,230,000 50.00% Pirelli & C. Real Estate S.p.A.Resi S.r.l. (ex- Dolcetto 5 S.r.l.) Real Estate Milan Euro 10,000 25.00% Pirelli & C. Real Estate S.p.A. Rinascente/Upim S.r.l. Real Estate Rozzano (Milan) Euro 10,000 20.00% Pirelli & C. Real Estate S.p.A.Riva dei Ronchi S.r.l. Real Estate Carrara Euro 100,000 35.00% Pirelli & C. Real Estate S.p.A.Roca S.r.l. (ex-M.S.M.C. Immobiare 6 S.r.l.) Real Estate Milan Euro 20,000 25.00% Pirelli & C. Real Estate S.p.A.

Pirelli & C. Real Estate FacilityS.AN.CO S.c.a.r.l. Real Estate Milan Euro 10,000 37.50% Management S.p.A.

Pirelli & C. Ambiente RenewableEnergy S.p.A. (ex- Pirelli & C.

Serenergy S.r.l. Enviroment Milan Euro 25,500 50.00% Ambiente S.p.A.) Solaris S.r.l. Real Estate Milan Euro 20,000 40.00% Pirelli & C. Real Estate S.p.A.Tamerice Immobiliare S.r.l. Real Estate Milan Euro 500,000 20.00% Pirelli & C. Real Estate S.p.A.

Pirelli & C. Real Estate FacilityTelepost S.p.A. Real Estate Milan Euro 120,000 20.00% Management S.p.A. Trixia S.r.l. Real Estate Milan Euro 1,209,700 36.00% Pirelli & C. Real Estate S.p.A.Turismo e Immobiliare S.p.A. Real Estate Milan Euro 120,000 25.00% Pirelli & C. Real Estate S.p.A.Verdi S.r.l. (in liquidation) Real Estate Milan Euro 20,000 43.74% Pirelli & C. Real Estate S.p.A. Vesta Finance S.r.l. Real Estate Conegliano (TV) Euro 10,000 35.00% Pirelli & C. Real Estate S.p.A. Waterfront Flegreo S.p.A. Real Estate Milan Euro 500,000 35.00% Pirelli & C. Real Estate S.p.A. LuxembourgAfrodite S.à r.l. Real Estate Luxembourg Euro 4,129,475 40.00% Pirelli & C. Real Estate S.p.A.Alimede Luxembourg S.à.r.l. Real Estate Luxembourg Euro 12,500 36.25% Pirelli & C. Real Estate S.p.A.Alnitak S.à r.l. Real Estate Luxembourg Euro 4,452,500 35.00% Pirelli & C. Real Estate S.p.A.Artemide S.à r.l. Real Estate Luxembourg Euro 2,857,050 35.00% Pirelli & C. Real Estate S.p.A.Austin S.à.r.l. Real Estate Luxembourg Euro 125,000 28.46% Pirelli & C. Real Estate S.p.A.Colombo S.à r.l. Real Estate Luxembourg Euro 960,150 35.00% Pirelli & C. Real Estate S.p.A.Dallas S.à.r.l. Real Estate Luxembourg Euro 125,000 28.46% Pirelli & C. Real Estate S.p.A.Doria S.à r.l. Real Estate Luxembourg Euro 992,850 35.00% Pirelli & C. Real Estate S.p.A.European NPL S.A. Real Estate Luxembourg Euro 1,851,126 33.00% Pirelli & C. Real Estate S.p.A.IN Holdings I S.à r.l. Real Estate Luxembourg Euro 4,595,725 20.50% Pirelli & C. Real Estate S.p.A.Inimm Due S.à r.l. Real Estate Luxembourg Euro 240,950 25.00% Pirelli & C. Real Estate S.p.A.Nashville S.à.r.l. Real Estate Luxembourg Euro 125,000 28.46% Pirelli & C. Real Estate S.p.A.Sicily Investments S.à.r.l. (ex- Marsala S.à.r.l.) Real Estate Luxembourg Euro 12,500 40.00% Pirelli & C. Real Estate S.p.A.Trinacria Capital S.à.r.l. (ex- Zibibbo S.à.r.l.) Real Estate Luxembourg Euro 12,500 40.00% Pirelli & C. Real Estate S.p.A.Trinoro S.à r.l. Real Estate Luxembourg Euro 30,000 35.00% Pirelli & C. Real Estate S.p.A.Vespucci S.à r.l. Real Estate Luxembourg Euro 960,150 35.00% Pirelli & C. Real Estate S.p.A.PortugalEspelha - Serviços de Consultadoria Lda Real Estate Madeira Euro 5,000 49.00% Pirelli & C. Real Estate S.p.A.

183



votingrights

SpainSignus Ecovalor S.L. Tyre Madrid Euro 200,000 20.00% Pireli Neumaticos S.A.The NetherlandsAlceo B.V. Real Estate Amsterdam Euro 18,000 33.00% Pirelli & C. Real Estate S.p.A.M.S.M.C. Italy Holding B.V. Real Estate Amsterdam Euro 20,000 25.00% Pirelli & C. Real Estate S.p.A.Masseto 1 B.V. Real Estate Amsterdam Euro 19,000 33.00% Pirelli & C. Real Estate S.p.A.Max B.V. Real Estate Amsterdam Euro 18,000 45.00% Pirelli & C. Real Estate S.p.A.Polish Investments Real Estate Holding B.V. Real Estate Amsterdam Euro 20,000 40.00% Pirelli & C. Real Estate S.p.A.Popoy Holding B.V. Financial Amsterdam Euro 26,550 25.05% Pirelli & C. Real Estate S.p.A.Spazio Industriale B.V. Real Estate Amsterdam Euro 763,077 25.00% Pirelli & C. Real Estate S.p.A.North AmericaU.S.A.Sci Roev Texas Partners L.P. Real Estate Dallas US $ 12,000,000 10.00% Pirelli & C. Real Estate S.p.A.Central/South AmericaArgentinaLineas de Transmision de Buenos Aires S.A. Pirelli Argentina (in liquidation) Services Buenos Aires Arg. Peso 12,000 20.00% de Mandatos S.A.

184


Other investments considered significant as per Consob resolution 11971 of May 14, 1999


votingrights

BelgiumEuroqube S.A. Services Brussels Euro 84,861,116 17.79% Pirelli & C. S.p.A.France

Pirelli Tyre S.p.A (ex- PirelliAliapur S.A. Tyre Lyons Euro 262,500 14.29% Pneumatici S.p.A.)HungaryHUREC Tyre Recycling Pirelli Hungary Tyre Trading andNon-Profit Company Tyre Budapest Hun. Forint 50,000,000 17.00% Services LtdItalyFin. Priv. S.r.l. Financial Milan Euro 20,000 14.29% Pirelli & C. S.p.A.Servizio Titoli S.p.A. Services Turin Euro 126,000 12.38% Pirelli & C. S.p.A.Tecnocittà S.r.l. (in liquidation) Real Estate Milan Euro 547,612 12.00% Pirelli & C. Real Estate S.p.A. PolandCentrum Utylizacji OponOtganizacja Odzyseu S.A. Tyre Warsaw Pol. Zloty 1,008,000 14.28% Pirelli Polska Sp. ZO.O.The NetherlandsMB Venture Capital Fund IParticipating Company G N.V. Financial Amsterdam Euro 50,000 14.00% Pirelli Finance (Luxembourg) S.A.Spazio Investment N.V.(ex- Spazio Industriale Investments I B.V.) Financial Amsterdam Euro 6,096,020 11.48% Pirelli RE Netherlands B.V.TunisiaSociété Tunisienne des Industries Pirelli Tyre S.p.A (ex- Pirelli de Pnéumatiques S.A. Tyre Tunis Tun. Dinar 42,078,240 15.83% Pneumatici S.p.A.)United KingdomTlcom I Ltd Partnership Financial London Euro 1,204 10.39% Pirelli Finance (Luxembourg) S.A.

185


186


Independent Auditors’ report

187


This report was prepared by the Directors in accordance with art. 72, paragraph one of Consob Regulation n. 11971 dated May 14, 1999 and subsequent amendments.

Amendment to articles 5 (Share capital), 6 (Shares), 7 (Shareholders meetings), 8 (constitutive and voting quorum), 9 (shareholders meetings proceeding), 10 (Company administration), 11 (duties of the Board of Directors), 12 (Board of Directors meetings), 13 (Company legal representation), 15 (dissolution of the Board of Directors) and 16 (Board of Statutory Auditors) of theCompany By-laws.

Dear Shareholders,

We have convened this extraordinary general meeting to submit to you the proposal to resolve uponsome amendments to the Company By-laws mainly relating to the need to conform them – by June 30,2007 – to the provision of law n. 262 of December 28, 2005 (so-called savings protection law), andmodified by legislative decree n. 303 of December 29, 2006, (so-called the corrective decree) thatrequires an adjustment, by June 30, 2007, of the By-Laws.

We have taken this opportunity to make further updatings and - as deemed a by the Board ofDirectors - improvements to the text, with the goal of making the By-laws clearer, more systematicand complete.

Furthermore are hereby proposed amendments which consider the recommendations and suggestionscontained in the new edition of the self-regulatory code for listed companies of March 2006 (the “NewSelf-Regulatory Code”).

Moreover please take note that in drawing up such proposals, it was not possible to take into accountConsob regulations issued in accordance with the savings protection law, as they were not availablewhen this meeting was convened.

In this respect, following the regulations issued by Consob, the Board of Directors reserves the rightto proceed with all necessary adjustments within the time-frame and modalities deemed moreappropriatein the times and modesaccording to appropriate time frames and means that areappropriate.

The following paragraphs illustrate in detail the above mentioned amendments in respect to eacharticle of the By-laws.

Article 5 (Share capital)The proposed amendments will (i) update the amount of the share capital and its structure at thedate of this report, and (ii) delete the fourth paragraph relating to share capital increase resolutionpertaining to the exercising of warrants on ordinary Pirelli & C. shares for 2003-2006, since June 30,2006 was the expiry term for share capital increases.

Article 6 (Shares)Besides making clear the fact that the savings shareholders’ organisation is regulated by law and theseBy-laws, the amendment aims at formally regulating what has until now been the general practiceadopted by the Company, by formalising in these By-laws that all costs pertaining to the organisationof the savings shareholders meetings as well as the fee due to the representative of such category ofshares, shall be borne by the Company.

188


Extraordinary session

Articles 7, 8 and 9 (Shareholders Meetings)The proposed amendments concern changes deriving from new Law implementation (new paragraphfive, article 7) as well as changes aimed at completing the internal regulatory framework (theintroduction of a new last paragraph in article 7 and amendments to articles 8 and 9).The first amendment, implementing the provisions of Law regarding savings protection, regulates thepossibility for shareholders to request additional items to the shareholders meetings agenda.Similarly to current legislative provisions for proposals made by the Board of Directors – thoughwithin shorter time periods (10 days instead of 15 days) – this amendment provides that the requestsfor additional items to the agenda made by shareholders be detailed in a report, to be made available,for completeness of information purposes, to the other shareholders before the shareholders meetingconvened to discuss the agenda, The second amendment to article 7, made to align the by-laws with the legislation in force, regulatesthe procedures for the convocation of savings shareholders meetings. Article 8 proposed amendment in order to avoid interpretation doubts regarding the application ofthe Rules of Proceeding, specifies that such Rules apply only to ordinary shareholders meetings.Eventually, in consistance with the other above mentioned amendments aimed at regulating in detailsome aspects relating to the organisation of the savings shareholders category, article 9 specifies theprocedures regarding the appointment of the Chairman of the shareholders meetings for suchcategory.

Articles 10, 11, 12, 13 and 15 (Board of Directors)Besides all amendments that are merely formal (such as those relating to articles 13 and 15) or thatsimplify operational procedures, we have proposed amendments to the regulations for the Board ofDirectors aimed at aligning the By-laws with the new regulatory framework.- Article 10. The terms for the presentation of the slates for the position of director have been made

more strict (i.e. at least 15 days before the date set for the first call of the shareholders meeting,instead of at least 10 days before). The alignment with the term recommended by the New Self-Regulatory Code if, on one hand, it involves fewer days for the shareholders to collect thedocuments necessary for the presentation of the slates, on the other it allows the market and othershareholders to obtain the information relating to the candidates for the directorship more quickly. Similarly, further proposals for modifications to article 10 regard aspects relating to the publicationof the slates and the characteristics of the documents to be presented along with the candidaturesproposed in the slates themselves. Lastly, regarding the necessary treshold for the presentation of the slates by shareholders for theappintment of the directors, which is currently set at two percent of ordinary share capital, we planto change it, if currently lower, so that it is equal to the level set by Consob regulations.

- Article 11. We propose the following three main modifications: (i) availing ourselves of thepossibilities provided by law, we propose to extend the duties currently attributed to the Board ofDirectors for the merger of companies owned in 90% or more, also in the case of so-called simplifiedde-mergers; (ii) we propose a simplification of the obligatory notifications to the Board of Directorsand the Board of Statutory Auditors by providing for the possibility that reports may be also givento them in written form and at meetings other than board or executive committee meetings; (iii)finally we provide – in alignment with provisions introduced through the savings protection law –that the Board of Directors appoint, subject to approval of the Board of Statutory Auditors, amanager responsible for the preparation of company accounting documents who must be an expertin administration, financial and auditing affairs, and who possesses the same requirements of goodstanding set for directors. Moreover we provide that this position has the same expiry term of theBoard of Directors that appointed him/her (thus keeping account of the relationship of trustbetween them), and that the loss of the requirements for such position constitutes forfeiture.

- Article 12. The proposed modification aligns the text of the by-laws with the new provisions inarticle 151 of legislative decree n. 58/1998 (Italian Financial Services Act), giving each StatutoryAuditor the faculty of convening meetings of the Board of Directors.

189


Article 16 (Board of Statutory Auditors)Regarding the changes of the regulations for the Board of Statutory Auditors, while awaiting the issueof Consob regulations, we propose to align the procedures for the appointment of members of thisBoard with those adopted for the Board of Directors. In order to conform the clause relating to the appointment of the Board of Statutory Auditors to theprovisions introduced in the Italian Financial Services Act on savings protection, we proposemoreover to eliminate the provision of statutory limits in respect to the total number of offices held (asubject that is also specifically regulated by Consob), modifying the regulations relating to theappointment system for the Chairman of the Board in order to provide – in the case of more than oneslate – that the name be taken from the so-called minority slate (also in case of their possiblereplacement).Together with the deposit of the curriculum vitae of each candidate, it is also required a list of all theoffices held in management and supervisory bodies (to be updated up to the day of the shareholdersmeeting in order to ensure that the provision in art. 2400 of the Italian Civil Code is respected), aswell as a declaration that the candidate possesses all of the requirements for the position, withoutprejudice to any additional documentation required by current legislation and regulations. Lastly, wepropose to define in the By-laws the regulations that shall be applied if only one slate is presented forthe appointment of the Chairman of the Board of Statutory Auditors.

* * *

If you agree to the above, we invite you to approve the following

Proposal

“The extraordinary Pirelli & C. S.p.A. shareholders meeting• in consideration of law n. 262 of December 28, 2005, (deemed the “savings protection law ”), and

modified by legislative decree n. 303 of December 29, 2006;• having examined the Report of the Directors detailing the proposals for modifications to articles 5

(share capital), 6 (shares), 7 (shareholders meetings), 8 (constitutive and voting quorum), 9 (procedures for shareholders meetings), 10 (Company administration), 11 (functions of the Boardof Directors), 12 (Board of Directors meetings), 13 (Company legal representation), 15 (dissolutionof the Board of Directors) and 16 (Board of Statutory Auditors) of these By-laws;

RESOLVES

a) to modify articles 5, 6, 7, 8, 9, 10, 11, 12, 13, 15 and 16 of the by-laws of Pirelli & C. S.p.A. in thetext below with highlights showing the amendments introduced:

190


EXISTING TEXT

NAME – PURPOSE – REGISTERED OFFICE – TERM

Article 1 A joint-stock company has been incorporatedunder the name Pirelli & C. Società per Azionior, in abbreviated form, Pirelli & C. S.p.A..

Article 2The Company’s purpose shall be: a) the acquisition of equity interests in other

companies or corporations, both in Italy andabroad;

b) the financing and the technical and financialcoordination of the companies orcorporations in which it holds interests;

c) the sale and purchase, ownership,management and/or placement of bothgovernment and private securities.

The company may carry out all operations ofany type whatsoever - excluding any activitiesreserved by law - connected to its corporatepurpose.

Article 3The registered office of the Company shall be inMilan.

Article 4The duration of the company shall be untilDecember 31, 2100.The extension of the term of duration does notaward the right of withdrawal to shareholderswho do not take part in the approval of therelating resolution.

SHARE CAPITAL

Article 5The Company shall have a subscribed and paid-in share capital of Euros 2,764,029,317.92 (twobillion, seven hundred and sixty-four million,twenty-nine thousand, three hundred andseventeen point nine two) divided into no.5,315,440,996 (five billion, three hundred andfifteen million, four hundred and forty thousand,nine hundred and ninety-six) shares with a parvalue of Euros 0.52 (fifty-two cents) each,consisting of n. 5,180,676,567 (five billion, onehundred and eighty million, six hundred andseventy-six thousand, five hundred and sixty-seven) ordinary shares and n. 134,764,429 (onehundred and thirty-four million, seven hundredand sixty-four thousand, four hundred and

PROPOSED TEXT

NAME – PURPOSE – REGISTERED OFFICE – TERM

Article 1 A joint-stock company has been incorporatedunder the name Pirelli & C. Società per Azionior, in abbreviated form, Pirelli & C. S.p.A..

Article 2The Company’s purpose shall be: a) the acquisition of equity interests in other

companies or corporations, both in Italy andabroad;

b) the financing and the technical and financialcoordination of the companies orcorporations in which it holds interests;

c) the sale and purchase, ownership,management and/or placement of bothgovernment and private securities.

The company may carry out all operations ofany type whatsoever – excluding any activitiesreserved by law – connected to its corporatepurpose.

Article 3The registered office of the Company shall be inMilan.

Article 4The duration of the company shall be untilDecember 31, 2100.The extension of the term of duration does notaward the right of withdrawal to shareholderswho do not take part in the approval of therelating resolution.

SHARE CAPITAL

Article 5The Company shall have a subscribed and paid-in share capital of EUR 2,791,311,344.64(twobillionssevenhundredandninetyonemil-lionsthreehundredandeleventhousands-threehundred-andfourtyfourpointsixtyfour)divided into no. 5,367,906,432 (fivebillions-threehundredsixtysevenmillionsninehundredandsixthousandsfour-hundredandthirtytwo)shares with a par value of EUR 0.52 (fiftytwocents) each, consisting of 5,233,142,003(fivebillionstwohundredandthirtythreemil-liosonehundredandfourtytwothousandsand-three) ordinary shares and 134,764,429(onehundredandthirtyfourmillionssevenhundredandsixtyfourthousandsfourhundredandtwenty-

191


twenty-nine) savings shares.In resolutions to increase the share capital byissuing shares against payment, pre-emptionrights may be excluded for up to a maximum often percent of the previously existing capital,provided that the issue price corresponds to themarket value of the shares and that this isconfirmed in a specific report prepared by thefirm appointed to audit the accounts.If so resolved by the shareholders meeting, theshare capital may also be increased by means ofcontributions in kind or of receivables.The extraordinary shareholders meeting held onMay 7, 2003 resolved to increase the sharecapital against payment, in divisible form, by andno later than June 30, 2006, in a maximumnominal amount of Euros 203,041,192.12 (atNovember 11, 2005 Euros 27,600,805.96), byissuing, even in more than one batch, up to amaximum of 390,463,831 (at November 11, 2005no. 53,078,473) ordinary shares against payment,with a par value of Euros 0.52 (fifty-two cents)each and regular dividend rights, to be reservedexclusively and irrevocably for the exercise of1,561,855,326 warrants (at November 11, 2005no. 212,313,894) issued in implementation of theresolution adopted by the same shareholdersmeeting on May 7, 2003.By resolution of the extraordinary shareholdersmeeting held on May 7, 2003, the directors wereauthorised to issue, on one or more occasionsbefore April 30, 2008, up to a maximum of100,000,000 (one hundred million) ordinaryshares, to be allocated to executive managersand cadres employed by the Company, by itssubsidiaries and by the subsidiaries of the latter,in Italy and abroad, in compliance with article2441, paragraph 8, of the Italian Civil Code andarticle 134 of Legislative Decree no. 58/1998. OnFebruary 25, 2005 the Board of Directorsresolved, in partial implementation of theauthorisation granted to it by the extraordinaryshareholders meeting held on May 7, 2003, toincrease the share capital by a maximumnominal amount of Euros 28,197,442 by issuingup to 54,225,850 ordinary shares with a par valueof Euros 0.52 each, at a price of Euros 1.15 pershare, inclusive of a Euros 0.63 share premium,to be reserved for subscription by executivemanagers and cadres employed by the Company,by its subsidiaries and by the latter’ssubsidiaries, in Italy and abroad.By resolution of the extraordinary shareholdersmeeting held on May 11, 2004, the directors wereauthorised to increase the share capital against

192


nine) savings shares.In resolutions to increase the share capital byissuing shares against payment, pre-emptionrights may be excluded for up to a maximum often percent of the previously existing capital,provided that the issue price corresponds to themarket value of the shares and that this isconfirmed in a specific report prepared by thefirm appointed to audit the accounts.If so resolved by the shareholders’ meeting, theshare capital may also be increased by means ofcontributions in kind or of receivables.

By resolution of the extraordinary shareholdersmeeting held on May 7, 2003, the directors wereauthorised to issue, on one or more occasionsbefore April 30, 2008, up to a maximum of100,000,000 (one hundred million) ordinaryshares, to be allocated to executive managersand cadres employed by the Company, by itssubsidiaries and by the subsidiaries of the latter,in Italy and abroad, in compliance with article2441, paragraph 8, of the Italian Civil Code andarticle 134 of Legislative Decree no. 58/1998. OnFebruary 25, 2005 the Board of Directorsresolved, in partial implementation of theauthorisation granted to it by the extraordinaryshareholders meeting held on May 7, 2003, toincrease the share capital by a maximumnominal amount of Euros 28,197,442 by issuingup to 54,225,850 ordinary shares with a par valueof Euros 0.52 each, at a price of Euros 1.15 pershare, inclusive of a Euros 0.63 share premium,to be reserved for subscription by executivemanagers and cadres employed by the Company,by its subsidiaries and by the latter’ssubsidiaries, in Italy and abroad.By resolution of the extraordinary shareholdersmeeting held on May 11, 2004, the directors wereauthorised to increase the share capital against

payment, on one or more occasions and withinMay 10, 2009, by a total maximum nominalamount of Euros 600 million, with or without ashare premium, by issuing up to a maximum of1,153,846,153 ordinary shares against payment,to be offered on option to shareholders andconvertible bondholders, with the possibility ofexcluding pre-emption rights, in compliance withthe combined provisions of article 2441, lastparagraph, of the Italian Civil Code and article134, paragraph 2, of Legislative Decree no.58/1998, if the shares are offered for subscriptionby the employees of Pirelli & C. S.p.A. and/or itssubsidiaries.By resolution of the extraordinary shareholdersmeeting held on May 11, 2004, the directors wereauthorised to issue, on one or more occasionswithin May 10, 2009, bonds that are convertibleinto ordinary and/or savings shares, or that carrywarrants valid for the subscription of saidshares, to be offered on option to shareholdersand convertible bondholders, corresponding to atotal maximum nominal amount of Euros 1,000million within the limits permitted each timeunder the laws in force, with the ensuingeventual increase of the share capital to backthe conversion of the bonds and/or exercise ofthe warrants.The resolutions passed by the Board ofDirectors to increase the share capital during theexercise of the rights allocated as describedabove shall set the share subscription price(inclusive of any share premium) as well as thespecific term for the subscription of the shares:they may also provide that, if the capitalincrease resolved is not fully subscribed by thedate set for this purpose, the capital shall beincreased by an amount corresponding to thesubscriptions received up to such date.

Article 6 The shares are divided into ordinary shares andsavings shares.Ordinary shares award the right to one vote pershare; they may be either registered or bearershares insofar as the law permits, and in thiscase may be converted from one type to theother, especially at the shareholder's request andexpense.Savings shares do not carry voting rights and,unless the law provides otherwise, are bearershares.They may be converted into registered shares onrequest and expense of the shareholder.

193


payment, on one or more occasions and withinMay 10, 2009, by a total maximum nominalamount of Euros 600 million, with or without ashare premium, by issuing up to a maximum of1,153,846,153 ordinary shares against payment,to be offered on option to shareholders andconvertible bondholders, with the possibility ofexcluding pre-emption rights, in compliance withthe combined provisions of article 2441, lastparagraph, of the Italian Civil Code and article134, paragraph 2, of Legislative Decree no.58/1998, if the shares are offered for subscriptionby the employees of Pirelli & C. S.p.A. and/or itssubsidiaries.By resolution of the extraordinary shareholdersmeeting held on May 11, 2004, the directors wereauthorised to issue, on one or more occasionswithin May 10, 2009, bonds that are convertibleinto ordinary and/or savings shares, or that carrywarrants valid for the subscription of saidshares, to be offered on option to shareholdersand convertible bondholders, corresponding to atotal maximum nominal amount of Euros 1,000million within the limits permitted each timeunder the laws in force, with the ensuingeventual increase of the share capital to backthe conversion of the bonds and/or exercise ofthe warrants.The resolutions passed by the Board ofDirectors to increase the share capital during theexercise of the rights allocated as describedabove shall set the share subscription price(inclusive of any share premium) as well as thespecific term for the subscription of the shares:they may also provide that, if the capitalincrease resolved is not fully subscribed by thedate set for this purpose, the capital shall beincreased by an amount corresponding to thesubscriptions received up to such date.

Article 6 The shares are divided into ordinary shares andsavings shares.Ordinary shares award the right to one vote pershare; they may be either registered or bearershares insofar as the law permits, and in thiscase may be converted from one type to theother, especially at the shareholder's request andexpense.Savings shares do not carry voting rights and,unless the law provides otherwise, are bearershares.They may be converted into registered shares onrequest and expense of the shareholder.

As well as any rights and privileges provided forby law and in other parts of these By-laws,savings shares shall have priority in the repaymentof the capital up to their entire par value; in theevent of a reduction of the share capital due tolosses, the par value of saving shares will bereduced only by the amount of the loss thatexceeds the total par value of the other shares.Savings shares shall retain the rights andprivileges contemplated by law and by these By-laws also in the event that the Company’sordinary and/or savings shares are de-listed.In the event of a share capital increase beingcarried out by issuing shares of only one class,such shares must be offered on option to theholders of all classes of shares.In the event of both ordinary and savings sharesbeing issued:a) the holders of ordinary shares shall be entitled

to receive an option on ordinary shares, andon savings shares to make up any difference;

b) the holders of savings shares shall be entitledto receive an option on savings shares, and onordinary shares to make up any difference.

Any introduction or removal of restrictions onthe circulation of shares does not award theright of withdrawal to shareholders who do nottake part in the approval of the related resolution.The savings shareholders’ organisation isgoverned by law and by these By-laws. Theexpenses related to the organisation of thespecial savings shareholders meetings andthe remuneration of the commonrepresentatives of savings shareholdersshall be borned by the Company.

SHAREHOLDERS MEETINGS

Article 7The calling of shareholders meetings, which maybe held anywhere in Italy, including in a placeother than the Company’s registered office, theright to attend meetings and representation atthe same are all regulated by law and by theseBy-laws. The notice of the call of an extraordinaryshareholders meeting may provide for it beingheld on third call.Shareholders for which the Company hasreceived the documentation pursuant to art.2370, paragraph 2, of the Italian Civil Code, atleast two days prior to the date set for eachmeeting shall be entitled to attend shareholdersmeetings.The ordinary shareholders meeting must be

194


As well as any rights and privileges provided forby law and in other parts of these By-laws,savings shares shall have priority in the repaymentof the capital up to their entire par value; in theevent of a reduction of the share capital due tolosses, the par value of saving shares will bereduced only by the amount of the loss thatexceeds the total par value of the other shares.Savings shares shall retain the rights andprivileges contemplated by law and by these By-laws also in the event that the Company’sordinary and/or savings shares are de-listed.In the event of a share capital increase beingcarried out by issuing shares of only one class,such shares must be offered on option to theholders of all classes of shares.In the event of both ordinary and savings sharesbeing issued:a) the holders of ordinary shares shall be entitled

to receive an option on ordinary shares, andon savings shares to make up any difference;

b) the holders of savings shares shall be entitledto receive an option on savings shares, and onordinary shares to make up any difference.

Any introduction or removal of restrictions onthe circulation of shares does not award theright of withdrawal to shareholders who do nottake part in the approval of the related resolution.

SHAREHOLDERS MEETINGS

Article 7The calling of shareholders meetings, which maybe held anywhere in Italy, including in a placeother than the Company’s registered office, theright to attend meetings and representation atthe same are all regulated by law and by theseBy-laws. The notice of the call of an extraordinaryshareholders meeting may provide for it beingheld on third call.Shareholders for which the Company hasreceived the documentation pursuant to art.2370, paragraph 2, of the Italian Civil Code, atleast two days prior to the date set for eachmeeting shall be entitled to attend shareholdersmeetings.The ordinary shareholders meeting must be

called within 120 days or, where specialcircumstances make this necessary, within 180days of the end of the Company’s financial year;if the meeting is called within 180 days, thedirectors shall give the reasons for the delay inthe directors’ report included in the year-endfinancial statements. Requests to add items to the agenda of thegeneral meetings presented by shareholdersin accordance with the law must be detailedby a report to be filed in the Company'sregistered office in time to be madeavailable to the other shareholders and atleast 10 days prior to the date set for themeeting on first call.Special meetings of savings shareholdersshall be convened by the commonrepresentative of savings shareholders orby the Board of Directors of the Companywhenever they deem necessary or inaccordance with law.

Article 8The due constitution of shareholders meetingsand the validity of the resolutions adopted bythe same are governed by law.The proceedings of shareholders meetings aregoverned by law, by these By-laws, and –solely for the ordinary and extraordinarygeneral meetings – by the Rules of Proceedingapproved by resolution of the Company’sordinary shareholders meeting.

Article 9 Ordinary and extraordinary shareholdersmeetings shall be chaired over by the Chairmanof the Board of Directors, by a Deputy Chairmanor by a Managing Director, in that order;whenever there are two or more DeputyChairmen or Managing Directors, the meetingswill be chaired by the elder of them. In theabsence of all of the aforementioned individuals,the meeting shall be chaired by another personelected with the favourable vote of the majorityof the capital represented at the meeting.The special meeting for savingsshareholders shall be chaired by thecommon representative for savingsshareholders or, in his absence, by theperson appointed with the favourable voteof the majority of the capital representedat the meeting. The Chairman shall be assisted by a Secretarywho is to be appointed with the favourable vote

195


called within 120 days or, where specialcircumstances make this necessary, within 180days of the end of the Company’s financial year;if the meeting is called within 180 days, thedirectors shall give the reasons for the delay inthe directors’ report included in the year-endfinancial statements.

Article 8The due constitution of shareholders meetingsand the validity of the resolutions adopted bythe same are governed by law.The proceedings of shareholders meetings,besides being regulated by law and by these By-laws, are also governed by the Rules ofProceeding approved by resolution of theCompany’s ordinary shareholders meeting.

Article 9 The Shareholders meetings shall be chaired overby the Chairman of the Board of Directors, by aDeputy Chairman or by a Managing Director, inthat order; whenever there are two or moreDeputy Chairmen or Managing Directors, themeetings will be chaired by the elder of them. Inthe absence of all of the aforementionedindividuals, the meeting shall be chaired byanother person elected with the favourable voteof the majority of the capital represented at themeeting.

The Chairman shall be assisted by a Secretarywho is to be appointed with the favourable vote

of the majority of the capital represented at themeeting and need not be a shareholder; there isno need to appoint a Secretary when a notarypublic is designated to draw up the minutes ofthe meeting.The Chairman of the shareholders meeting shallchair the meeting and govern its proceedings incompliance with the law and these By-laws. Tothis end, the Chairman shall, amongst otherthings: verify that the meeting is dulyconstituted; ascertain the identity of thosepresent and their right to attend, including byproxy; ascertain the legal quorum for passingresolutions; direct the business, including byestablishing a different order for the discussionof the items listed on the agenda in the noticeconvening the meeting. The Chairman shall alsotake appropriate measures to ensure the orderlyconduct of discussions and votes and shallestablish the procedures and ascertain theresults thereof. The resolutions of shareholders meetings shallbe recorded in the minutes that must be signedby the Chairman of the meeting and by theSecretary or the notary public.The minutes of extraordinary shareholdersmeetings must be drawn up by a notary publicappointed by the Chairman of the meeting.Any copies of and extracts from minutes thathave not been drawn up by a notary public shallbe certified as true copies by the Chairman ofthe Board of Directors.

ADMINISTRATION OF THE COMPANY

Article 10The Company shall be managed by a Board ofDirectors composed of no less than seven andno more than twenty three members who shallremain in office for three financial years (unlessthe shareholders meeting establishes a shorterterm at the time of their appointment) and maybe re-elected. The shareholders meeting shallestablish the number of members of the Boardof Directors, which shall remain unchanged untilsaid meeting resolves otherwise.The Board of Directors shall be appointed on thebasis of slates presented by the shareholderspursuant to the following paragraphs hereof, inwhich the candidates are listed by consecutivenumber. The slates presented by the shareholders, whichmust be undersigned by the parties submittingthem, shall be filed at the Company’s registeredoffice, and be available to anyone on request, at

196


of the majority of the capital represented at themeeting and need not be a shareholder; there isno need to appoint a Secretary when a notarypublic is designated to draw up the minutes ofthe meeting.The Chairman of the shareholders meeting shallchair over the meeting and govern itsproceedings in compliance with the law andthese By-laws. To this end, the Chairman shall,amongst other things: verify that the meeting isduly constituted; ascertain the identity of thosepresent and their right to attend, including byproxy; ascertain the legal quorum for passingresolutions; direct the business, including byestablishing a different order for the discussionof the items listed on the agenda in the noticeconvening the meeting. The Chairman shall alsotake appropriate measures to ensure the orderlyconduct of discussions and votes and shallestablish the procedures and ascertain theresults thereof. The resolutions of shareholders meetings shallbe recorded in the minutes that must be signedby the Chairman of the meeting and by theSecretary or the notary public.The minutes of extraordinary shareholdersmeetings must be drawn up by a notary publicappointed by the Chairman of the meeting.Any copies of and extracts from minutes thathave not been drawn up by a notary public shallbe certified as true copies by the Chairman ofthe Board of Directors.

ADMINISTRATION OF THE COMPANY

Article 10The Company shall be managed by a Board ofDirectors composed of no less than seven andno more than twenty three members who shallremain in office for three financial years (unlessthe shareholders meeting establishes a shorterterm at the time of their appointment) and maybe re-elected. The shareholders meeting shallestablish the number of members of the Boardof Directors, which shall remain unchanged untilsaid meeting resolves otherwise.The Board of Directors shall be appointed on thebasis of slates presented by the shareholderspursuant to the following paragraphs hereof, inwhich the candidates are listed by consecutivenumber. The slates presented by the shareholders, whichmust be undersigned by the parties submittingthem, shall be filed at the Company’s registeredoffice, and be available to anyone on request, at

least ten days before the date set for theshareholders meeting to be held on first call. Each shareholder may present or take part inthe presentation of only one slate and eachcandidate may appear on only one slate on painof ineligibility.Only shareholders who, alone or together withother shareholders, hold a total number ofshares representing at least 2 percent of theshare capital entitled to vote at the ordinaryshareholders meeting are entitled to submitslates, subject to their proving ownership of thenumber of shares needed for the presentation ofslates at least two days prior to the date set forthe shareholders meeting to be held on first call.

Together with each slate, and within therespective terms specified above, statementsmust be filed in which the individual candidatesagree to their nomination and attest, under theirown liability, that there are no grounds for theirineligibility or incompatibility, and that theymeet any requisites prescribed for the positions.Together with such statements, a curriculumvitae must be filed for each candidate, settingout their relevant personal and professional dataand specifying, where appropriate, the groundson which they qualify as an independentcandidate.

Any slates submitted without complying with theforegoing provisions shall be disregarded. Each person entitled to vote may vote for onlyone slate.The Board of Directors shall be elected asspecified below:a) four-fifths of the directors to be elected shall

be chosen from the slate which obtains thehighest number of votes cast by theshareholders, in the order in which they arelisted on the slate; in the event of a fractionalnumber, it shall be rounded-down to thenearest whole number;

b) the remaining directors shall be chosen fromthe other slates; to this end, the votesobtained by the various slates shall be dividedfirst by one, then by two, then by three, then

197


least fifteen days before the date set for theshareholders meeting to be held on first call. Each shareholder may present or take part inthe presentation of only one slate and eachcandidate may appear on only one slate on painof ineligibility.Only shareholders who, alone or together withother shareholders, hold a total number ofshares representing at least 2 percent of theshare capital entitled to vote at the ordinaryshareholders meeting or the minorpercentage, according to the regulationsissued by Commissione Nazionale per lesocietà e la borsa, are entitled to submit slates,subject to their proving ownership of thenumber of shares needed for the presentation ofslates at least two days prior to the date set forthe shareholders’ meeting to be held on first call. Together with each slate, and within therespective terms specified above, statementsmust be filed in which the individual candidatesagree to their nomination and attest, under theirown liability, that there are no grounds for theirineligibility or incompatibility, and that theymeet any requisites prescribed for the positions.Together with such statements, a curriculumvitae must be filed for each candidate, settingout their relevant personal and professional dataand mentioning the offices held inmanagement and supervisory bodies of othercompanies and specifying, where appropriate,the grounds on which they qualify as anindependent candidate in accordance with thecriteria established by law and theCompany. Any changes that occur up to thedate the Shareholders’ meeting must bepromptly notified to the Company.Any slates submitted without complying with theforegoing provisions shall be disregarded. Each person entitled to vote may vote for onlyone slate.The Board of Directors shall be elected asspecified below:a) four-fifths of the directors to be elected shall

be chosen from the slate which obtains thehighest number of votes cast by theshareholders, in the order in which they arelisted on the slate; in the event of a fractionalnumber, it shall be rounded-down to thenearest whole number;

b) the remaining directors shall be chosen fromthe other slates; to this end, the votesobtained by the various slates shall be dividedby whole progressive numbers from one

by four – and so on – according to thenumber of directors to be elected. Thequotients thus obtained shall be assigned tothe candidates on each slate in the order theyare respectively listed thereon. On the basisof the quotients assigned, the candidates onthe various slates shall be ranked in a singlelist in decreasing order. Those who haveobtained the highest quotients shall be elected.If more than one candidate obtains the samequotient, the candidate from the slate that hasnot yet elected a director or that has electedthe lowest number of directors shall beelected.If none of such slates has as yet elected adirector or they have all elected the samenumber of directors, the candidate from theslate which obtained the highest number ofvotes shall be elected. If the different slatesobtain the same number of votes and theircandidates are assigned the same quotients, anew vote shall be held by the entireshareholders meeting and the candidate whoobtains the simple majority of the votes shallbe elected.

When appointing directors who, for whatsoeverreason, were not appointed under the procedureestablished herein, the shareholders meetingshall vote on the basis of the majorities requiredby law.If one or more vacancies occur on the Board ofdirectors during the course of the financial year,the procedure established in article 2386 of theItalian Civil Code shall be followed.The Board of Directors shall elect its ownChairman, if the shareholders meeting has notalready done so, and may also appoint one ormore Deputy Chairmen. In the absence of the Chairman, a DeputyChairman or a Managing Director, in that order,shall act in his/her stead; should there be two ormore Deputy Chairmen or Managing Directors,the Board shall be presided over by the elder ofthem.The Board shall appoint a Secretary, who neednot be a director.Until the shareholders meeting resolvesotherwise, the directors shall not be subject tothe prohibition contemplated in article 2390 ofthe Italian Civil Code.

Article 11The Board of Directors shall conduct themanagement of the company and is accordingly

198


up to the number of directors to be elected.The quotients thus obtained shall be assignedto the candidates on each slate in the orderthey are respectively listed thereon. On thebasis of the quotients assigned, the candidateson the various slates shall be ranked in asingle list in decreasing order. Those whohave obtained the highest quotients shall beelected.If more than one candidate obtains the samequotient, the candidate from the slate that hasnot yet elected a director or that has electedthe lowest number of directors shall beelected.If none of such slates has as yet elected adirector or they have all elected the samenumber of directors, the candidate from theslate which obtained the highest number ofvotes shall be elected. If the different slatesobtain the same number of votes and theircandidates are assigned the same quotients, anew vote shall be held by the entireshareholders’ meeting and the candidate whoobtains the simple majority of the votes shallbe elected.

When appointing directors who, for whatsoeverreason, were not appointed under the procedureestablished herein, the shareholders meetingshall vote on the basis of the majorities requiredby law.If one or more vacancies occur on the Board ofDirectors during the course of the financial year,the procedure established in article 2386 of theItalian Civil Code shall be followed.The Board of Directors shall elect its ownChairman, if the shareholders meeting has notalready done so, and may also appoint one ormore Deputy Chairmen. In the absence of the Chairman, a DeputyChairman or a Managing Director, in that order,shall act in his/her stead; should there be two ormore Deputy Chairmen or Managing Directors,the Board shall be presided over by the elder ofthem.The Board of Directors shall appoint a Secretary,who need not be a director.Until the shareholders meeting resolvesotherwise, the directors shall not be subject tothe prohibition contemplated in article 2390 ofthe Italian Civil Code.

Article 11The Board of Directors shall conduct themanagement of the company and is accordingly

vested with the broadest powers ofadministration, except for those remitted by lawor by these By-laws to the authority of theshareholders meeting.Within the limits established by law, the Boardof Directors shall be authorised to decide on themerger of companies in which Pirelli & C. S.p.A.owns at least 90 percent of the shares or quotas,the reduction of the share capital in the event ofthe withdrawal of shareholders, the revision ofthe By-laws to conform with statutoryprovisions, the relocation of the registered officewithin Italy, and the opening and closing ofbranch offices

The Board of Directors and the Board ofStatutory Auditors shall be kept informed, alsoby corporate bodies with delegated powers, onthe activities carried out, the generalperformance of operations and their foreseeabledevelopment, and the transactions of greatesteconomic, financial and equity-relatedsignificance concluded by the Company or itssubsidiaries; in particular, said corporate bodieswith delegated powers shall report ontransactions in which they have an interest,directly or on behalf of third parties, or that areinfluenced by the party that performsmanagement and coordination activities, if any.Such reports shall be made promptly, on aquarterly basis at the least, on the occasion ofthe meetings of the Board of Directors and theExecutive Committee - if established - or in awritten memorandum.In accordance with the established times andprocedures for disclosing information to themarket, the representative of the holders ofsavings shares must be informed by the Board ofDirectors or by the persons delegated for suchpurpose about any corporate events that mightaffect the price of the shares in that class.In the context of the management of theCompany, the Board of Directors shall beauthorised to delegate those powers which itdeems appropriate to one or more of its members,possibly with the title of Managing Director, andgrant them the single or joint signature powers itdecides appropriate to establish.It may also delegate its powers to an ExecutiveCommittee composed of some of its ownmembers, whose remuneration shall beestablished by the shareholders meeting.It may also establish one or more committees

199


vested with the broadest powers ofadministration, except for those remitted by lawor by these By-laws to the authority of theshareholders meeting. Within the limits established by law, the Boardof Directors shall be authorised to decide on themerger of companies in Pirelli & C. S.p.A. orde-merger in favour of Pirelli & C. S.p.A. ofcompanies in which Pirelli & C. S.p.A. owns atleast 90 percent of the shares or quotas, thereduction of the share capital in the event of thewithdrawal of shareholders, the revision of theBy-laws to conform with statutory provisions,the relocation of the Company’s registered officewithin Italy, and the opening and closing ofbranch offices. The Board of Directors and the Board ofStatutory Auditors shall be kept informed, alsoby corporate bodies with delegated powers, onthe activities carried out, the generalperformance of operations and their foreseeabledevelopment, and the transactions of greatesteconomic, financial and equity-relatedsignificance concluded by the Company or itssubsidiaries; in particular, said corporate bodieswith delegated powers shall report ontransactions in which they have an interest,directly or on behalf of third parties, or that areinfluenced by the party that performsmanagement and coordination activities, if any.Such reports shall be made promptly, on aquarterly basis at the least, in a writtenmemorandum.

In accordance with the established times andprocedures for disclosing information to themarket, the representative of the holders ofsavings shares must be informed by the Board ofDirectors or by the persons delegated for suchpurpose about any corporate events that mightaffect the price of the shares in that class.In the context of the management of theCompany, the Board of Directors shall beauthorised to delegate those powers which itdeems appropriate to one or more of its members,possibly with the title of Managing Director, andgrant them the single or joint signature powers itdecides appropriate to establish.It may also delegate its powers to an ExecutiveCommittee composed of some of its ownmembers, whose remuneration shall beestablished by the shareholders meeting.It may also establish one or more committees

with consulting and propositional functions, alsofor purposes of adjusting the corporategovernance structure in line with therecommendations issued from time to time bythe pertinent authorities.

Lastly, the Board of Directors may appointgeneral managers, deputy general managers,managers and deputy managers and attorneys-in-fact to carry out certain operations or categoriesof operations, establishing their powers andfunctions. The appointment of managers, deputymanagers and attorneys-in-fact to carry outcertain operations or categories of operationsmay also be remitted by the Board to theManaging Directors and the General Managers.

Article 12The Board of Directors shall meet, at theinvitation of the Chairman or whoever acts inhis/her stead, at the Company’s registered officeor at any other venue stated in the letter ofconvocation, whenever he/she deems itappropriate in the best interests of the Companyor receives a written request to do so from oneof the Managing Directors or one-fifth of thedirectors in office or at least two standingmembers of the Board of Statutory Auditors.

The Chairman shall give advance notice of thematters to be discussed at Board meetings andarrange for adequate information on the

200


with consulting and propositional functions, alsofor purposes of adjusting the corporategovernance structure in line with therecommendations issued from time to time bythe pertinent authorities.The Board of Directors shall appoint - withthe consent of the Board of StatutoryAuditors - the manager responsible forpreparing the Company’s financial reports.His office shall expire at the same time asthat of the Board of Directors thatappointed him/her, unless annulment forgood cause, with the consent of the Boardof Statutory Auditors.The manager responsible for preparing theCompany’s financial reports must be anexpert on administration, finances andauditing of companies and satisfy theintegrity qualifications required to be adirectors. Failing of such qualificationsshall determine the termination of theoffice to be resolved by the Board ofDirectors within thirty days since theacknowledgement of the defect.Lastly, the Board of Directors may appoint generalmanagers, deputy general managers, managersand deputy managers and attorneys-in-fact tocarry out certain operations or categories ofoperations, establishing their powers andfunctions. The appointment of managers, deputymanagers and attorneys-in-fact to carry out certainoperations or categories of operations may also beremitted by the Board of Directors to theManaging Directors and the General Managers.

Article 12The Board of Directors shall meet, at theinvitation of the Chairman or whoever acts inhis/her stead, at the Company’s registered officeor at any other venue stated in the letter ofconvocation, whenever he/she deems itappropriate in the best interests of the Companyor receives a written request to do so from oneof the Managing Directors or one-fifth of theDirectors in office.

The meeting of the Board of Directors canalso be convened by the Board of StatutoryAuditors, or by a single Statutory auditor,subject to prior notice given to theChairman of the Board of Directors. The Chairman shall give advance notice of thematters to be discussed at Board meetings andarrange for adequate information on the

questions to be examined to be provided to allthe directors, taking account of thecircumstances of each case. Board meetings shall be called by letter,telegram, fax or e-mail, to be sent to eachdirector and standing member of the Board ofStatutory Auditors at least five days prior (or inurgent cases, with at least six hours’ notice) tothe date scheduled for the meeting.Even when a Board meeting is not formallycalled, resolutions of the Board of Directorsshall nevertheless be valid if adopted in thepresence of all the Board members in office andall the standing members of the Board ofStatutory Auditors.Board meetings - and meetings of the ExecutiveCommittee, if established - may, if the Chairmanor whoever acts in his/her stead verifies thenecessity, be attended by means oftelecommunications systems that permit allattendees to participate in the discussion andobtain information on an equal basis. Meetings of the Board of Directors, and of theExecutive Committee, if established, shall beconsidered held at the place in which theChairman and the Secretary must besimultaneously located. Resolutions of the Board shall only be valid ifadopted in the presence of the majority of Boardmembers and by majority vote. In the event ofa tied vote, the Chairman shall hold the castingvote.Resolutions of the Board of Directors, includingthose adopted at meetings held viatelecommunications, must be recorded in aspecific minutes book and signed by theChairman and the Secretary of the meeting. Anycopies of and extracts from minutes that havenot been drawn up by a notary public shall becertified as true copies by the Chairman.

Article 13The legal representation of the Company vis-à-vis third parties and in court proceedings shallpertain separately to the Chairman of the Boardof Directors and, within the limits of the powersgranted to them by the Board of Directors, tothe Deputy Chairmen and the ManagingDirectors, if appointed.Each of the aforementioned shall in any event bevested with all powers to bring legal actions andfile petitions before any judicial authority and atall levels of jurisdiction, including in appeal andSupreme Court proceedings, to file statements

questions to be examined to be provided to allthe directors, taking account of thecircumstances of each case. Board meetings shall be called by letter,telegram, fax or e-mail, to be sent to eachdirector and standing member of the Board ofStatutory Auditors at least five days prior (or inurgent cases, with at least six hours’ notice) tothe date scheduled for the meeting.Even when a Board meeting is not formallycalled, resolutions of the Board of Directorsshall nevertheless be valid if adopted in thepresence of all the Board members in office andall the standing members of the Board ofStatutory Auditors.Board meetings – and meetings of the ExecutiveCommittee, if established – may, if the Chairmanor whoever acts in his/her stead verifies thenecessity, be attended by means oftelecommunications systems that permit allattendees to participate in the discussion andobtain information on an equal basis. Meetings of the Board of Directors, and of theExecutive Committee, if established, shall beconsidered held at the place in which theChairman and the Secretary must besimultaneously located. Resolutions of the Board of Directors shall onlybe valid if adopted in the presence of themajority of Board members and by majorityvote. In the event of a tied vote, the Chairmanshall hold the casting vote.Resolutions of the Board of Directors, includingthose adopted at meetings held viatelecommunications, must be recorded in aspecific minutes book and signed by theChairman and the Secretary of the meeting. Anycopies of and extracts from minutes that havenot been drawn up by a notary public shall becertified as true copies by the Chairman.

Article 13The legal representation of the Company vis-à-vis third parties and in court proceedings shallpertain separately to the Chairman of the Boardof Directors and, within the limits of the powersgranted to them by the Board of Directors, tothe Deputy Chairmen and the ManagingDirectors, if appointed.Each of the aforementioned shall in any event bevested with all powers to bring legal actions andfile petitions before any judicial authority and atall levels of jurisdiction, including in appeal andSupreme Court proceedings, to file statements

201


202


and charges in criminal cases, to sue on behalfof the Company in criminal proceedings, to bringlegal proceedings and file petitions before alladministrative jurisdictions, to intervene andprotect the Company's interests in anyproceedings and claims concerning the Companyand to grant the mandates and powers ofattorney ad litem required for such purpose.The Board of Directors and, within the limits ofthe powers granted to them by said Board, theChairman of the Board of Directors and, ifappointed, the Deputy Chairmen and theManaging Directors, shall be authorised to grantthe power to represent the Company vis-à-visthird parties and in court proceedings tomanagers and staff in general and, whennecessary, to third parties.

Article 14 In addition to the reimbursement of all expensessustained by reason of their office, members ofthe Board of Directors shall be entitled to anannual emolument established by theshareholders meeting.The remuneration of directors vested withspecial office shall be established by the Boardof Directors after obtaining the opinion of theBoard of Statutory Auditors.

Article 15If, due to resignations or for any other reason,more than half of the seats on the Board becomevacant, the entire Board of Directors shall bedeemed to have resigned and cease to holdoffice with effect as of the time of itsreconstitution.

BOARD OF STATUTORY AUDITORS

Article 16The Board of Statutory Auditors shall becomposed of three standing and two alternateauditors, who must be in possession of therequisites established under applicable laws andregulations; to this end, it shall be borne in mindthat the fields and sectors of business closelyconnected with those of the Company are thosestated in the Company’s purpose, with particularreference to companies or corporationsoperating in the financial, industrial, banking,insurance and real estate sectors and in theservices field in general.The ordinary shareholders meeting shall electthe Board of Statutory Auditors and determine

and charges in criminal cases, to sue on behalfof the Company in criminal proceedings, to bringlegal proceedings and file petitions before alladministrative jurisdictions, to intervene andprotect the Company's interests in anyproceedings and claims concerning the Companyand to grant the mandates and powers ofattorney ad litem required for such purpose.The Board of Directors and, within the limits ofthe powers granted to them by said Board ofDirectors, the Chairman of the Board ofDirectors and, if appointed, the DeputyChairmen and the Managing Directors, shall beauthorised to grant the power to represent theCompany vis-à-vis third parties and in courtproceedings to managers and staff in generaland, when necessary, to third parties.

Article 14 In addition to the reimbursement of all expensessustained by reason of their office, members ofthe Board of Directors shall be entitled to anannual emolument established by theshareholders meeting.The remuneration of directors vested withspecial office shall be established by the Boardof Directors after obtaining the opinion of theBoard of Statutory Auditors.

Article 15If, due to resignations or for any other reason,more than half of the seats on the Board becomevacant, the entire Board of Directors shall bedeemed to have resigned and cease to holdoffice with effect as of the time of itsreconstitution.

BOARD OF STATUTORY AUDITORS

Article 16The Board of Statutory Auditors shall becomposed of three standing and two alternateauditors, who must be in possession of therequisites established under applicable laws andregulations; to this end, it shall be borne in mindthat the fields and sectors of business closelyconnected with those of the Company are thosestated in the Company’s purpose, with particularreference to companies or corporationsoperating in the financial, industrial, banking,insurance and real estate sectors and in theservices field in general.The ordinary shareholders meeting shall electthe Board of Statutory Auditors and determine

its remuneration. The minority shareholdersshall be entitled to appoint one standing auditorand one alternate auditor.With the exception of the provisions of the third-to-last paragraph of this article 16, the Board ofStatutory Auditors shall be appointed on thebasis of slates presented by the shareholders inwhich candidates are listed by consecutivenumber.Each slate shall contain a number of candidateswhich does not exceed the number of membersto be appointed. Shareholders who, alone or together with othershareholders, represent at least 2 percent of theshares with voting rights in the ordinaryshareholders meeting, shall be entitled to submitslates, subject to their proving ownership of thenumber of shares needed for the presentation ofslates at least two days prior to the date set forthe shareholders meeting to be held on first call.Each shareholder may present or take part inthe presentation of only one slate.

The slates of candidates, which must beundersigned by the parties submitting them,shall be filed in the Company’s registered officeand be available to anyone on request, at leastten days prior to the date set for theshareholders meeting to be held on first call. Aprofessional curriculum of the individualsstanding for election must be enclosed with theslates together with statements in which theindividual candidates agree to their nominationand attest, under their own liability, that thereare no grounds for their ineligibility orincompatibility, and that they meet the requisitesprescribed by law or by these By-laws for theposition.

Any slates submitted without complying with theforegoing provisions shall be disregarded.Each candidate may appear on only one slate,on pain of ineligibility.Furthermore, those individuals who are not inpossession of the requisites established by theapplicable rules and regulations, or who alreadyhold the position of standing auditor in more

its remuneration. The minority shareholdersshall be entitled to appoint one standing auditorand one alternate auditor.With the exception of the provisions of the third-to-last paragraph of this article 16, the Board ofStatutory Auditors shall be appointed on thebasis of slates presented by the shareholders inwhich candidates are listed by consecutivenumber.Each slate shall contain a number of candidateswhich does not exceed the number of membersto be appointed. Shareholders who, alone or together with othershareholders, represent at least 2 percent of theshares with voting rights in the ordinaryshareholders’ meeting or the minorpercentage, according to the regulationsissued by Commissione Nazionale per lesocietà e la borsa, shall be entitled to submitslates, subject to their proving ownership of thenumber of shares needed for the presentation ofslates at least two days prior to the date set forthe shareholders’ meeting to be held on first call.Each shareholder may present or take part inthe presentation of only one slate.The slates of candidates, which must beundersigned by the parties submitting them,shall be filed in the Company’s registered officeand be available to anyone on request, at leastfifteen days prior to the date set for theshareholders’ meeting to be held on first call. Apersonal and professional curriculum,mentioning also the offices held inmanagement and supervisory bodies ofother companies, of the individuals standingfor election must be enclosed with the slatestogether with statements in which the individualcandidates agree to their nomination and attest,under their own liability, that there are nogrounds for their ineligibility or incompatibility,and that they meet the requisites prescribed bylaw, by these By-laws and by regulation for theposition.Any changes that occur up to the date theShareholders’ meeting must be promptlynotified to the Company.Any slates submitted without complying with theforegoing provisions shall be disregarded.Each candidate may appear on only one slate,on pain of ineligibility.

203


204


than five companies whose securities are listedon regulated Italian markets, with the exceptionof the subsidiaries of Pirelli & C., cannot beelected to the Board of Statutory Auditors.The slates shall be divided into two sections:one for candidates for the position of standingauditor and one for candidates for the positionof alternate auditor. The first candidate listed ineach section must be selected from among thepersons enrolled in the Register of Auditors whohave worked on statutory audits for a period ofno less than three years. Each person entitled to vote may vote for onlyone slate.The Board of Statutory Auditors shall be electedas specified below: a) two standing members and one alternate

member shall be chosen from the slate whichobtains the highest number of votes (knownas the majority slate), in the consecutiveorder in which they are listed thereon;

b) the remaining standing member and the otheralternate member shall be chosen from theslate which obtains the highest number ofvotes cast by the shareholders after the firstslate (known as the minority slate), in theconsecutive order in which they are listedthereon; if several slates obtain the samenumber of votes, a new vote between saidslates will be cast by all the shareholdersattending the meeting, and the candidates onthe slate which obtains the simple majority ofthe votes will be elected.

The chair of the Board of Statutory Auditorsshall be given to the standing member listed asthe first candidate on the slate which obtains thehighest number of votes.The position of a standing auditor which fallsvacant due to his/her death, forfeiture orresignation shall be filled by the alternateauditor chosen from the same slate as theformer. In the event of the replacement of theChairman of the Board of Statutory Auditors, thechair shall be given to the other standingmember chosen from the same slate as theformer Chairman; if it proves impossible toeffect substitutions and replacements under theforegoing procedures, a shareholders meetingshall be called to complete the Board ofStatutory Auditors which shall adopt resolutionsby relative majority vote.When the shareholders meeting is required,pursuant to the provisions of the foregoingparagraph or to the law, to appoint the standing

The slates shall be divided into two sections:one for candidates for the position of standingauditor and one for candidates for the positionof alternate auditor. The first candidate listed ineach section must be selected from among thepersons enrolled in the Register of Auditors whohave worked on statutory audits for a period ofno less than three years. Each person entitled to vote may vote for onlyone slate.The Board of Statutory Auditors shall be electedas specified below: a) two standing members and one alternate

member shall be chosen from the slate whichobtains the highest number of votes (knownas the majority slate), in the consecutiveorder in which they are listed thereon;

b) the remaining standing member and the otheralternate member shall be chosen from theslate which obtains the highest number ofvotes cast by the shareholders after the firstslate (known as the minority slate), in theconsecutive order in which they are listedthereon; if several slates obtain the samenumber of votes, a new vote between saidslates will be cast by all the shareholdersattending the meeting, and the candidates onthe slate which obtains the simple majority ofthe votes will be elected.

The chair of the Board of Statutory Auditorsshall pertain to the standing member listed asthe first candidate on the slate mentioned inpoint b) of the paragraph above.The position of a standing auditor which fallsvacant due to his/her death, forfeiture orresignation shall be filled by the alternateauditor chosen from the same slate as theformer. In the event of the replacement of theChairman of the Board of Statutory Auditors, thechair shall pertain to the candidate listed inthe same slate of the former Chairman,following the order contained in the list; ifit proves impossible to effect substitutions andreplacements under the foregoing procedures, ashareholders’ meeting shall be called tocomplete the Board of Statutory Auditors whichshall adopt resolutions by relative majority vote.When the shareholders meeting is required,pursuant to the provisions of the foregoingparagraph or to the law, to appoint the standing

205


and/or alternate members needed to completethe Board of Statutory Auditors, it shall proceedas follows: if auditors elected from the majorityslate have to be replaced, the appointment shallbe made by relative majority vote without slateconstraints; if, however, auditors elected fromthe minority slate have to be replaced, theshareholders meeting shall replace them byrelative majority vote, selecting them wherepossible from amongst the candidates listed onthe slate on which the auditor to be replacedappeared.

When appointing auditors who, for whatsoeverreason, were not appointed under theprocedures established herein, the shareholdersmeeting shall vote on the basis of the majoritiesrequired by law.Outgoing members of the Board of StatutoryAuditors may be re-elected to office.Meetings of the Board of Statutory Auditors may,if the Chairman or whoever acts in his/her steadverifies the necessity, be attended by means oftelecommunications systems that permit allattendees to participate in the discussion andobtain information on an equal basis.

FINANCIAL STATEMENTS - ALLOCATION OF PROFITS

Article 17The company’s financial year shall close onDecember 31 of each year.

Article 18Following the mandatory allocations to statutoryreserves, the Company’s net year-end profitsshall be distributed as follows:a) savings shares shall be awarded a dividendcorresponding to a maximum of seven percentof their par value; if a dividend of less thanseven percent of par value is awarded to savingsshares in a given financial year, the differenceshall be computed as an increase to be added tothe preference dividend over the subsequent twofinancial years; any profits remaining followingthe award of the aforementioned dividend to

and/or alternate members needed to completethe Board of Statutory Auditors, it shall proceedas follows: if auditors elected from the majorityslate have to be replaced, the appointment shallbe made by relative majority vote without slateconstraints; if, however, auditors elected fromthe minority slate have to be replaced, theshareholders meeting shall replace them byrelative majority vote, selecting them wherepossible from amongst the candidates listed onthe slate on which the auditor to be replacedappeared.In case only one slate has been presented,the shareholders’s meeting shall vote on it;if the slate obtains the relative majority,the candidates listed in the respectivesection shall be appointed to the office ofstanding auditors and alternate auditors;the candidate listed at the first place in theslate shall be appointed as Chairman of theBoard of Statutory Auditors. When appointing auditors who, for whatsoeverreason, were not appointed under theprocedures established herein, the shareholdersmeeting shall vote on the basis of the majoritiesrequired by law.Outgoing members of the Board of StatutoryAuditors may be re-elected to office.Meetings of the Board of Statutory Auditors may,if the Chairman or whoever acts in his/her steadverifies the necessity, be attended by means oftelecommunications systems that permit allattendees to participate in the discussion andobtain information on an equal basis.

FINANCIAL STATEMENTS - ALLOCATION OF PROFITS

Article 17The company’s financial year shall close onDecember 31 of each year.

Article 18Following the mandatory allocations to statutoryreserves, the Company’s net year-end profitsshall be distributed as follows:a) savings shares shall be awarded a dividendcorresponding to a maximum of seven percentof their par value; if a dividend of less thanseven percent of par value is awarded to savingsshares in a given financial year, the differenceshall be computed as an increase to be added tothe preference dividend over the subsequent twofinancial years; any profits remaining followingthe award of the aforementioned dividend to

savings shares shall be distributed amongst allthe shares in such a way that savings sharesshall receive an aggregate dividend which ishigher, compared to the dividend awarded toordinary shares, by an amount corresponding totwo percent of their par value;b) without prejudice to the foregoing provisionsregarding the aggregate higher dividendsawarded to savings shares, ordinary shares shallbe awarded a dividend corresponding to amaximum of five percent of their par value.The remaining profits shall be distributedamongst all the shares, in addition to theallocations contemplated in the foregoing pointsa) and b), unless the shareholders meeting, onthe proposal of the Board of Directors, resolvesto make special allocations to extraordinaryreserves or for other uses, or decides to carrysome of such profits forward to the next year.Should reserves be distributed, savings sharesshall be awarded the same rights as othershares.Interim dividends may be distributed incompliance with the law.

GENERAL PROVISIONS

Article 19Insofar as their relations with the Company areconcerned, the domicile of the shareholders isunderstood, for all legal purposes, to be thatreported in the Shareholders’ Register.

Article 20All matters not specifically regulated in these By-laws shall be governed by the applicableprovisions of the law.

savings shares shall be distributed amongst allthe shares in such a way that savings sharesshall receive an aggregate dividend which ishigher, compared to the dividend awarded toordinary shares, by an amount corresponding totwo percent of their par value;b) without prejudice to the foregoing provisionsregarding the aggregate higher dividendsawarded to savings shares, ordinary shares shallbe awarded a dividend corresponding to amaximum of five percent of their par value.The remaining profits shall be distributedamongst all the shares, in addition to theallocations contemplated in the foregoing pointsa) and b), unless the shareholders meeting, onthe proposal of the Board of Directors, resolvesto make special allocations to extraordinaryreserves or for other uses, or decides to carrysome of such profits forward to the next year.Should reserves be distributed, savings sharesshall be awarded the same rights as othershares.Interim dividends may be distributed incompliance with the law.

GENERAL PROVISIONS

Article 19Insofar as their relations with the Company areconcerned, the domicile of the shareholders isunderstood, for all legal purposes, to be thatreported in the Shareholders’ Register.

Article 20All matters not specifically regulated in these By-laws shall be governed by the applicableprovisions of the law.

206


Il Consiglio di AmministrazioneMilano, 12 marzo 2007

b) To grant to the Board of Directors – and therefore to the Chairman and Deputy Chairman severally– all the powers necessary to fill the resolution taken in the Company’s Register, accepting andintroducing all the amendments which might be necessary or required by law.

ANNUAL REPORT 2006 SUSTAINABILITY

T A B L E O F C O N T E N T S pag.

1. PIRELLI AND SUSTAINABLE DEVELOPMENT 208

A note on methodology 209

1 . 1 . I D E N T I F I C A T I O N O F S T A K E H O L D E R S A N D A P P R O A C H A D O P T E D 209

1 . 2 . G O V E R N A N C E O F C O R P O R A T E S O C I A L R E S P O N S I B I L I T Y * 210

1 . 3 . M A N A G E M E N T S Y S T E M S A P P L I E D A N D R E F E R E N C E S T A N D A R D S 216

1 . 4 . S U S T A I N A B I L I T Y I N D E X E S 216

2. ECONOMIC DIMENSION 218

2 . 1 . A D D E D V A L U E 218

2 . 2 . S H A R E H O L D E R S 220

2 . 3 . C U S T O M E R S 221

2 . 4 . S U P P L I E R S 226

3. ENVIRONMENTAL DIMENSION 229

3 . 1 . T H E P I R E L L I A P P R O A C H T O E N V I R O N M E N T A L M A N A G E M E N T 229

3 . 2 . P I R E L L I T Y R E S S . P. A . 230

3 . 3 . P I R E L L I B R O A D B A N D S O L U T I O N S S . P. A . 252

3 . 4 . P I R E L L I & C . R E A L E S T A T E S . P. A . 252

3 . 5 . P I R E L L I & C . A M B I E N T E S . P. A . 258

3 . 6 . P I R E L L I L A B S S . P. A . 265

4. SOCIAL DIMENSION 267

4 . 1 . I N T E R N A L C O M M U N I T Y 267

4 . 2 . E X T E R N A L C O M M U N I T Y 295

Table of contents 303

Glossary 305

Terms marked with the symbol * are explained in the glossary

1. PIRELLI AND SUSTAINABLE DEVELOPMENT

“A well-run multinational corporation does not just export investments,production, technologies and expertise. It also exports progressivepersonnel policies, state-of- the-art environmental protection systemsand standards of behaviour that are at least on a par with thoseadopted in the other regions of the world in which it operates.

By its very nature, the multinational corporation exports respect for thedifferent cultures with which it has to operate and interact, drawingnew life-force from them in terms of ideas and how situations areaddressed.

It exports social responsibility.

It does not, therefore, just grow available wealth, it also contributes toraising the ethical level of the economic environment."

Marco Tronchetti Provera

Chairman, Pirelli Group

208


A note on methodology

This, the second edition of the Pirelli Group Sustainability* Report, is intended to be a full and com-plete expression of the Pirelli corporate culture. It does this by reporting the group’s economicchoices together with its environmental and social choices, in line with the ‘triple bottom line’approach. For this reason, the details of our sustainable performance are included in the AnnualReport, instead of being published separately. This is a clear sign of the importance that sustainabledevelopment holds for Pirelli, and at the same time it encourages us to operate to the satisfaction ofall stakeholders*. It is, in short, a move towards growth that is both sound and long-lasting.

The report has been drawn up according to the Sustainability Reporting Guidelines* issued by theGlobal Reporting Initiative (GRI*). Analysis of sustainable performance is based on a set of KeyPerformance Indicators *(KPI), developed in conformance with GRI indicators (updated to the G3standard) and according to the principles of the Global Compact, and also taking account of dataperiodically monitored by the major rating agencies.

The sections on economic and social relations have also drawn on the ‘Principles of SustainabilityReport Accounting’ issued by the Sustainability Report Study Group of the Italian Ministry ofLabour and Social Policy.

In this section we have concentrated on what we believe will be of most interest to the reader,bearing in mind the wide variety of stakeholders. We have shown Pirelli’s corporate social respon-sibility in its essence, without undue enphasis on the goals that have been achieved, while trans-parently illustrating critical issues that have emerged, and highlighting and explaining theprogress in 2006 of what was reported in 2005.

1 . 1 . I D E N T I F I C A T I O N O F S T A K E H O L D E R S A N D A P P R O A C H A D O P T E D

The term ‘stakeholder’ means ‘holder of legitimate interests’ in the company, i.e. parties (individ-uals or groups) who have an interest in the company’s decisions, influence its success and/or areinfluenced by the organisation’s activities.

Pirelli Group encompasses several different business areas, each of which is responsible for sus-tainability as it affects that business area. Consequently, relations with stakeholders are to a cer-tain degree heterogeneous, which may be regarded as a beneficial diversity in Pirelli’s ways of lis-tening to and involving stakeholders.

Pirelli Group adopts a multi-stakeholder approach, which means that it pursues lasting and sus-tainable growth based as far as possible on the equable reconciliation of the interests and expec-tations of all who interact with the company, in particular:

» Environment

» Shareholders

» Human Resources

» Customers

» Suppliers

» Institutions

» External Community

209


There are many and varied initiatives, activities, tools for dialogue and projects of specific inter-est to the categories of stakeholders listed above. These are explained in detail in chapters 2, 3and 4 of this report, to which the reader is referred for further information.

1 . 2 . G O V E R N A N C E O F C O R P O R A T E S O C I A L R E S P O N S I B I L I T Y *

As regards corporate identity and Group organization, please see Preliminary Information andDirectors’ Report that precede this section.

For Pirelli, governance of CSR means integrating sustainability with the various different aspectsand precincts of company management. Among other things, this translates to the mapping, con-trol and sustainable management of all risks associated with the company’s activities.

Clear evidence of this approach is found in the Group's advanced Principles of CorporateGovernance and in its Sustainability Documents, which together support Pirelli’s Vision andMission on the subject of sustainable development*.

The sustainability model adopted by the Group is in its turn based on the principles of the UnitedNations Global Compact, to which Pirelli has formally adhered since 2004.

Operational management of CSR benefits from an effective organisational structure that extendsthroughout the company and which was set up in order to better govern the Group’s sustainabili-ty. To this must be added the recently-issued operative procedure for Corporate SocialResponsibility, which sets out and regulates the methods for internal management of activitiesassociated with Corporate Social Responsibility, with particular attention to the roles and respon-sibilities of the departments involved. These regulations also govern the planning and controlprocesses and the process of drawing up this Sustainability Report.

The following sections contain a more detailed discussion of the topics mentioned above.

C O R P O R A T E G O V E R N A N C E

As part of its tradition of transparency and integrity, Pirelli actively participates in reciprocal rela-tions with the financial community (and in particular with shareholders, both institutional and pri-vate), by organising periodical meetings in Italy and abroad and by ensuring that all stakeholdersreceive the same level of information, as specified by current legislation in force.

In recent years Pirelli Group has set up a Corporate Governance system in line with best practicesin Italy and beyond.

Of particular note in this regard is the recent effort to nominate independent and minority repre-sentatives in the company’s board of directors. As of 12 March 2007, independent directors repre-sent over fifty per cent of the total (ten out of nineteen, four of which are nominated by the‘minorities’).

In order to take full advantage of the role played by independent directors, the Group’s Board ofDirectors starting from November 2005 decided to introduce the role of Lead IndependentDirector, who acts as a point of reference and coordination for all independent directors.

For more details and discussion please see the Corporate Governance Report. In addition, the

210


homepage of the corporate website (www.pirelli.com) gives access to the webpage for theGroup’s Corporate Governance system.

V I S I O N

Right from its origins, Pirelli has always been aware that its performance as a company could not beconsidered exclusively from an economic point of view, but that it would also have to account forits contribution to the quality of the environment and the social system, in view of the complex con-nections and interactions that exist between the economic, social and environmental dimensions.

Pirelli considers that the principal challenge that a company must confront in order to be sustain-able and to remain in business over time is that of creating value. The company must reconcile theexpectations of the various stakeholders, even where these are not in agreement with those of thecompany.

Based on this principle, Pirelli prefaces its ‘Policy for Health, Safety, Environment and SocialResponsibility’ as follows:

“Pirelli supports and respects the protection of internationally-proclaimed human rights, iscommitted to implementing the ethical code approved by the Board and is engaged in continu-ous improvement of social, ethical, health and safety and environmental aspects. Pirelli con-siders the protection of the integrity, health and welfare of its employees and of the environ-ment as one of the primary needs that is to be respected in organizing its activities. Pirelliabides the principle of ‘Sustainable Development’ and undertakes to put it into practice.”

T H E M I S S I O N I N T H E G R O U P ’ S S U S T A I N A B I L I T Y D O C U M E N T S

T H E V A L U E S A N D E T H I C A L C O D E O F T H E P I R E L L I G R O U P

In order to provide all the Group’s affiliates with convincing and uniform guidelines on the profes-sional practices to be followed by those working in the company, in July 2003 the Board ofDirectors of Pirelli & C. S.p.A. approved the ‘The Values and Ethical Code of the Pirelli Group’.

The document has been translated into the languages spoken within the Group and issued to allPirelli employees. The document is publicly available in the ‘Sustainability’ area of the Pirelli web-site (www.pirelli.com).

The Group’s ethical code outlines the general principles (transparency, correctness and loyalty)that inspire the way it does business. It summarises the objectives and values of the company’sactivities with regard to the main stakeholders that Pirelli & C. S.p.A. regularly interacts with:shareholders, the financial market, associates, customers, and the community.

Observance of the ethical code is required by a specific clause inserted by Pirelli in its GeneralConditions for Purchase of Goods and Services. Please see the ‘Suppliers’ section for more details.

The nine articles of the ethical code are not given in the present paragraph, but are reported asopening statements to the relevant pargraphs.

211


P I R E L L I P O L I C Y O N H E A L T H , S A F E T Y, E N V I R O N M E N T

A N D S O C I A L R E S P O N S I B I L I T Y

Within an international context in which the economic, environmental and social expectations areever more demanding, the policy adopted by Pirelli in June 2004 has further enhanced the correctbalance between sustainability and industrial development. As well as introducing the principle ofsustainable development, Pirelli’s policy for Health, Safety, Environment and Social Responsibilitybrings together in a single document the previous policies on the environment (first drawn up inJuly 1995 and updated in September 2000) and on safety at work (September 1995).

Pirelli Group has always considered the protection of the integrity, health and welfare of itsemployees and of the environment as one of the primary needs that is to be respected in organiz-ing its activities, by adhering to the principle of sustainable development and by striving to com-mit, among others, to the following principles:

» to manage its activities by adopting health, safety, environmental and social account-ability Management Systems in compliance with international standards;

» to communicate and spread health, safety, environmental and social accountabilityinformation to internal and external stakeholders, actively co-operating with nation-al and international academic and legislative bodies;

» to promote the use of the most advanced technologies in order to achieve the excel-lence in safety, workers’ health and environment protection;

» to assess and reduce the environmental impact of its processes/products by adoptingthe LCA (Life Cycle Assessment) approach;

» to use material resources responsibly, with a view to achieving sustainable growththat respects the environment and the rights of future generations;

» to appraise the risks of work injury or occupational ill health in order to eliminate orreduce them, by complying with the legislation in the various different countries asa minimum requirement;

» not to engage in or support the use of child labour and forced labour;

» to ensure equal opportunity, freedom of association, and to promote the develop-ment of each individual;

» to establish and maintain appropriate procedures to evaluate and select suppliersand subcontractors based on their commitments to social and environmentalaccountability;

» to involve all levels of the organization and all Group employees by assuring thatresponsibilities and operating procedures are precisely defined, appropriately com-municated and clearly understood.

Pirelli is committed to continuously improve its policy and programmes, as it is committed toimplement procedures, rules and instructions serving to ensure that the values embodied in thepolicy are reflected in the conduct of each company and in the conduct of its employees and col-laborators.

The HSE & CSR policy has been translated into the various different languages spoken within theGroup and issued to all Pirelli employees, in the same way as for the ethical code.

212


Observance of the HSE & CSR policy is required by a specific clause inserted by Pirelli in itsGeneral Conditions for Purchase of Goods and Services. Please see the ‘Suppliers’ section formore details.

The text of the policy is publicly available in the ‘Sustainability’ area of the Pirelli website(www.pirelli.com).

P I R E L L I G R O U P E Q U A L O P P O R T U N I T I E S S T A T E M E N T

Pirelli’s commitment to equal opportunities in the workplace is clearly set out in its ‘EqualOpportunities Statement’, signed by the Group’s Chairman.

This document is the fulcrum of the Group’s equal opportunities programme. For more informa-tion on this programme, please see the ‘Social Dimension’ section.

The declaration:

» confirms Pirelli’s strong commitment, as firm today as in has been in the past, to com-ply with the principles of equal opportunities in the workplace, without any form ofdiscrimination on the basis of gender, marital status, sexual orientation, religious orpolitical beliefs, union membership, colour, ethnic origins, nationality, age or disabil-ity;

» declares Pirelli’s opposition to any and all forms of discrimination, direct and indi-rect, and/or harassment of individuals or groups by others;

» sanctions Pirelli’s commitment to preventing discrimination in all areas of workinglife, including selection and all decisions related to remuneration, professional sta-tus, the assignment of responsibilities, training and career development, and speci-fies that all such decisions are made solely and exclusively on the basis of the com-petence, experience and professional potential that individuals possess and theresults that they achieve.

The declaration also indicates the objectives that Pirelli has set itself:

» acknowledge and promote the importance of individual differences in all companyprocesses;

» identify and eliminate any form of discrimination that may hinder equal access toemployment opportunities;

» guarantee genuine equality of treatment of all company employees in every sector,role and level of seniority and in all positions of responsibility, thereby acknowledg-ing the results and potential of all individuals;

» foster diversification in individual professional choices.

The declaration has been translated into the various different languages spoken within the Groupand issued to all Pirelli employees at the end of 2006. The document is publicly available in the‘Sustainability’ area of the Pirelli website (www.pirelli.com).

T H E G R O U P ’ S S U S T A I N A B I L I T Y M O D E L : T H E U N G L O B A L C O M P A C T

The concept of the Global Compact was first proposed on 31 January 1999 in Davos by the thenSecretary General of the UN, Kofi Annan, in an appeal to the World Economic Forum.The Secretary General invited the leaders of the world economy to adhere to the Global Compact,

213


an international initiative to support specific, universal principles that would bring together com-panies, UN agencies, unions and civil society.

The Global Compact is a voluntary initiative intended to promote responsible company policies,and is based on a network centred around the Global Compact Office and several UN agencies.

More specifically, the Global Compact requires companies to implement and support ten basicprinciples in their spheres of influence. The principles cover human rights, working standards, theenvironment and the fight against corruption. They are universally shared, and are directly basedon the Universal Declaration of Human Rights, the Declaration of the International LabourOrganisation on Fundamental Principles and Rights at Work, the Rio Declaration on Environmentand Development, and the United Nations Convention against Corruption.

In October 2004 in a letter to the then Secretary General of the UN, Kofi Annan, Pirelli Group for-mally declared its adherence to the Global Compact and its commitment to observe and supportthe ten principles.

In particular, this letter included the following passage:

“With this communication, we express our intent to support and advance those principles with-in our sphere of influence. We commit to making the Global Compact and its principles part ofthe strategy, culture and day-to-day operations of our company and undertake to make a clearstatement of this commitment - both to our employees, partners, clients and to the public.We support public accountability and transparency and will report on progress made in a pub-lic manner.”

Pirelli has always been attentive to the environment and human rights, and the Group’s commit-ment in this regard has been formalised in recent years with the publication of ‘The Values andEthical Code of the Pirelli Group’ in 2003 and the ‘Pirelli Group Policy for Health, Safety,Environment and Social Responsibility’ in 2004 (both of which are discussed above). The applica-tion of these policies completely fulfils the principles of the Global Compact.

Within the required deadline, Pirelli provided the Global Compact Office with evidence of thedevelopment and progress reached in its sustainable activities.

M A N A G E M E N T O F C O R P O R A T E S O C I A L R E S P O N S I B I L I T Y

O R G A N I S AT I O N A L S T R U C T U R E O F C O R P O R AT E S O C I A L R E S P O N S I B I L I T Y

Governance of Corporate Social Responsibility is centred around the Corporate SocialResponsibility Steering Committee, a high-level organ that was formed at the beginning of 2004 bythe Chairman to guide and supervise the advancement of CSR throughout the Group. The CSRorganisational structure is made up of a Group HSE&CSR Director, a Group CSR Manager, SectorCSR Managers (one for each sector of the Group) and Company CSR Managers (one for each affil-iated company in the Group).

In conformance with the above-cited principle “…ensure equal opportunity… promote the devel-opment of each individual” declared in the Policy for Health, Safety, Environment and SocialResponsibility (see above) and to implement article 6 of the Group’s ethical code, which says“Working relationships are managed with a view to guaranteeing equal opportunities and pro-

214


moting the personal development of each employee”, in 2005 the Chairman nominated an EqualOpportunities Steering Committee*, a high-level organ to guide and supervise programmes forequal opportunities in the company. At the same time, in order to steer the implementation of theEqual Opportunities Programme (see above) within the Group, and also to achieve better organi-sational balance and to monitor the advancement of equal opportunities at all affiliated compa-nies, an Equal Opportunities Manager was nominated for the Group as a whole. Finally there areEqual Opportunities Managers for each country, who are responsible for guiding and supervisingthe advancement of equal opportunities at a local level.

2 0 0 6 O P E R AT I V E P R O C E D U R E O N C O R P O R AT E S O C I A L R E S P O N S I B I L I T Y

On 16 September 2006 the Operative Procedure on Corporate Social Responsibility was releasedand distributed throughout the Group.

Taking its cue from the shared Preface, which states “Attention to all stakeholders (employees,customers, suppliers, shareholders, the environment, the community etc.) enables the companyto manage and improve its impact on the environment and on society, and at the same timeincreasing the creation of value”, this document sets out and regulates the methods for internalmanagement of activities associated with Corporate Social Responsibility, with particular atten-tion to the roles and responsibilities of the departments involved. These regulations also governthe planning and control processes, the process of drawing up this Sustainability Report, and theprocesses of managing the dissemination of CSR information to the external community.

In particular, the Operative Procedure expressly specifies the full integration of CSR into theGroup’s financial reporting structure (“The cycle of planning and control of CSR follows theGroup’s reporting and planning calendar”), along with the approvals procedure for projects thathave an impact on CSR, the process for planning objectives, and finally the methods of reportingCSR to the external community, to meet the increasing needs of the markets to assess a compa-ny’s degree of sustainability at an international level.

N E W I T S Y S T E M * F O R M A N A G I N G C S R I N F O R M A T I O N

The Group is developing a new IT system for managing CSR information. This system should beoperational by the end of 2007.

The system is geared towards achieving further efficiencies in the process of contribution, valida-tion, consolidation, analysis and management of information relating to CSR.

The new IT system will become an extremely valuable tool for everyone who deals with CSR with-in the Group. It will further improve the qualitative and quantitative monitoring of the progress ofsustainability at all levels – local, Sector and Group.

215


1 . 3 . M A N A G E M E N T S Y S T E M S A P P L I E D A N D R E F E R E N C E S T A N D A R D S

To implement the first principle of the Policy for Health, Safety, Environment and SocialResponsibility, Pirelli devotes significant resources to management systems, availing of these tools toimprove the quality, effectiveness and efficiency of its processes. This results in further reductions inthe impacts on the health of its employees, on safety conditions in the workplace and on the environ-ment.

These systems are fully described in their relevant paragraphs in the sections below.

In 2004 the international SA 8000* standard was adopted as the point of reference for assessing theconsistency of the Group’s conduct with the CSR principles defined in that standard.

1 . 4 . S U S T A I N A B I L I T Y I N D E X E S

Pirelli Group's commitment to CSR and the positive results achieved in thits area have won signif-icant recognition by means of the company’s inclusion in some of the most prestigious internation-al stock exchange indices for sustainability.

D O W J O N E S S U S T A I N A B I L I T Y I N D E X

Pirelli was selected for the Dow Jones Sustainability STOXX (DJSI STOXX) index for the first timein 2002. Today it is included in both the Dow Jones Sustainability World index and the STOXXindex.

Launched in 1999, the Dow Jones Sustainability Indices are the first global indices to track thefinancial performance of leading companies in terms of sustainability. The indices, which arebased on the cooperative efforts of Dow Jones, STOXXLimited and SAM, provide reliable, objec-tive information in terms of benchmarks for managers of sustainable fund portfolios.

F T S E I N D E X E S

Pirelli has been included in the FTSE Global and Europe indices since 2002.

FTSE is an independent company, held by the Financial Times and the London Stock Exchange.

The FTSE4Good Series indices were created by FTSE to measure the performance of companiesin terms of their observance of internationally-recognised standards of social responsibility, andto facilitate investment in these companies.

216


FTSE4GOOD 2006 LOGO

A S P I I N D E X

Pirelli has been included in the ASPI Eurozone® index since the beginning of 2005.

The family of ASPI Eurozone® indices (the acronym stands for Advanced SustainablePerformance Indices) includes the 120 best-performing companies in terms of sustainability (thereference world are the companies included in the DJ EURO STOXXSM index).

S I R I S U S T A I N A B I L I T Y A S S E S S M E N T

Pirelli’s assessment in 2006 was the second best in its industrial sector with a score that wasapproximately 30% higher than the sector average.

Sustainable Investment Research International Ltd is the biggest independent research and con-sulting body for socially-responsible investments worldwide for institutional investors and finan-cial professionals. SIRI publishes detailed profiles of the 600 most important international groups.

A X I A I N D E X E S

Pirelli has been included in the Axia Ethical Index since 2004 (the year the index was created) andin the Axia CSR Index since 2005 (the year the index was created).

Pirelli is also included in the Axia Euro Ethical Index and the Axia Euro CSR Index.

Pirelli entered the Axia CSR indices with a rating of A++, one of the highest on the Axia scale. TheAxia indices follow international best practices in corporate social responsibility, on a range ofcompanies selected from those with the biggest capitalisations from the S&P MIB andEurostoxx60. The Axia indices interact with the major international platforms for financial oper-ators.

217


2. ECONOMIC DIMENSION

The companies in Pirelli Group are committed to contributing to the economic well-being andgrowth of the community in which they operate, by providing efficient and technologicallyadvanced services. (article 5 of the Ethical Code - ‘Community’).

2 . 1 . A D D E D V A L U E

Added value means the wealth created over a given period, calculated as the difference betweenthe revenues generated and the external costs sustained in the period.

The distribution of added value between the stakeholders allows to express, in monetary terms,the existing relations between Pirelli and the major stakeholders, so shifting attention to the socio-economic system in which the Group operates (as shown in the diagram below).

218


CUSTOMERS

EMPLOYEESPUBLIC

ADMINISTRATIONFINANCIERS SHAREHOLDERS COMPANY

OUTSIDECOMMUNITY

SALARIESSEVERANCEINDEMNITY

COMPANY BENEFITSSOCIAL COSTS

TAXESAND LEVIES

FINANCIALCHARGES

SHAREDPROFITS

DEPRECIATIONPROVISIONS

UNSHARED PROFITS

OUTSIDEDONATIONS

OVERALL ADDED VALUE

SUPPLIERSREVENUES COSTS

The added value created by Pirelli & C. Group in 2006 was shared out as follows:

Year 2006(1) Year 2005(thousands of euro) % (thousands di euro) %

GROSS OVERALL ADDED VALUE 1,996,516 1,836,320 A. Payments to personnel (1,075,819) 53.9% (1,029,880) 56.1%B. Payments to Public Administration (127,849) 6.4% (128,484) 7.0%C. Payments of credit capital (126,976) 6.4% (90,672) 4.9%D. Payments of venture capital (78,299) 3.9% (149,492) 8.1%E. Payments to the company (579,535) 29.0% (429,361) 23.4%F. Ouside donations (8,038) 0.4% (8,431) 0.5%

1 The gross overall added value for 2006 does not take into account non-recurring operations recorded in the period. Inparticular: the disposal to third parties of 38.9% of Pirelli Tyre SpA and the entire holding in Capitalia (631 million euro),and the costs sustained for the IPO (13 million euro) and the depreciation of the affiliate company Olimpia (2,110 millioneuro).

The table below shows the contributions and donations made by Gruppo Pirelli & C. in 2005 and2006, subdivided by category:

Year 2006 Year 2005AREA OF INTERVENTION (thousands of euro) (thousands of euro)Education 1,246 799Culture 5,188 5,533Sport 244 450Research 339 290Solidarity 739 914Other 282 445TOTAL 8,038 8,431

It may readily be seen that the contributions and donations made in 2006 are mainly in line withthe previous year.

Please see the ‘Social dimension’ section, subsection ‘Corporate initiatives' for the external com-munity’, for a detailed description of the principal actions associated with these contributions anddonations.

Finally, the companies in the Group “do not contribute or confer advantages or other benefitsupon political parties and trade union organizations or their representatives and candidates,without prejudice to compliance with the relevant prevailing legislation” (from article 5,‘Community’, of the Ethical Code).

219


2 . 2 . S H A R E H O L D E R S

“Group companies are committed to ensuring equal treatment for all categories of sharehold-ers, avoiding any preferential treatment. The reciprocal benefits that derive from belonging toa group of companies are pursued in accordance with the relevant legislation and theautonomous interests of each Group Company as it seeks to create value” (article 3 of the EthicalCode - Shareholders).

Ordinary shares – the most common form of holding in the company’s share capital – confer ontheir holders voting rights at ordinary and extraordinary shareholders’ meetings. Among otherfunctions, these meetings serve to approve the financial statements, nominate the members of thecompany organs and modify the articles of association.

Savings shares confer to their holders a series of rights listed in article 6 of the articles of associ-ation, in addition to a privileged position in the distribution of profits.

In this regard, article 18 of the articles of association of Pirelli & C. specifies the preferential with-drawal on annual earnings (known as the ‘preferential dividend’) as 7 per cent of the nominalshare value of these shares (euro 0.52). In addition, the earnings that remain after assigning thepreferential dividend are divided among all shares so that the savings shares receive a larger div-idend than ordinary shares, by an amount of at least two per cent of the nominal share value.

Finally, it should be noted that if the company does not distribute profits (i.e. it distributes lessthan 7 per cent of the nominal value), savings shareholders have the right to recover the minimumdividend for this period in the following two periods.

Savings shareholders do not have voting rights or the right to ask questions at ordinary sharehold-ers’ meetings. However, they can attend the special savings shareholders’ meeting to elect (or dis-miss) their common representative and to deliberate resolutions on topics concerning their sharecategory.

Among other things, the Common Representative of the savings shareholders has the right toattend (as an observer) the ordinary shareholders’ meetings of the company, regardless of theirnature or agenda, and to contest resolutions adopted by the meeting.

It is the company’s constant and unwavering policy to take advantage of the shareholders’ meet-ings to disseminate information about the company and its prospects to the shareholders.Obviously this activity is conducted in observance of regulations governing the confidentiality ofinformation and hence where necessary this information is simultaneously released to the market.Great care is also taken in the choice of location, date and time of the meeting, in order to facili-tate the attendance of shareholders. Finally, the company has adopted a series of “Regulations forShareholders’ Meetings”. This document regulates ordinary and extraordinary shareholders’ meet-ings, and it guarantees the right of each member to speak on topics under discussion.

Based on data in the shareholders’ register, the body of ordinary shareholders is made up of acomponent of ‘core’ shareholders who hold approximately 52% of ordinary share capital. Theremaining 48% of this capital (known as ‘free float’) is subdivided jointly between institutionalinvestors (10% of which are foreign) and retail investors (numbering approximately 107,000).

The ‘core’ shareholders adhere to a shareholders’ agreement, the “Pirelli & C. S.p.A. Block ShareSyndicate”. The objective of this agreement is to ensure a stable shareholder base and a uniformstrategy in the management of the company. At the present time this agreement includes approx-imately 46.2% of the ordinary shares issued.

A top priority of Pirelli & C. S.p.A. is the establishment and maintenance of constant dialogue withits shareholders and with institutional investors. To this end, in the early 1990s the company setup an investor relations department, which was tasked with implementing an ongoing programmeof communication and dissemination of information to the financial community and in particularto investors (institutional and retail), financial analysts and sales representatives.

220


Relations with the financial community are maintained through the organisation of meetings orconference calls (over 200 in 2006) to present the company’s periodic economic & financial resultsand the related strategies for development.

One of the methods for disseminating information that deserves special mention is Pirelli’s web-site. From the website’s home page visitors can access the investor relations area, which containsall documents distributed at meetings with the financial community, documents containing pub-lished economic and financial information about the company, and all other documents relatingto the company’s corporate governance system.

A further indication of the importance that Pirelli accords the market is the fact that both theGroup parent company, Pirelli & C. S.p.A., and its subsidiary, Pirelli & C. Real Estate S.p.A. (alsolisted on the electronic trading system organised and managed by the Italian stock exchange),have prepared an innovative information tool exclusively for retail investors: the Shareholders’Manual. This document is the end product of company experience based on international bestpractices, and it may be downloaded from the Pirelli website.

2 . 3 . C U S T O M E R S

T Y P E O F G R O U P C U S T O M E R S

The types of customer served by Pirelli Group differ greatly from one business area to the next.

The tyre sector serves the following categories of customer:

» Original Equipment, which includes the leading international makers of cars, motor-cycles, scooters, commercial vehicles (light, medium and heavy), buses and agricul-tural machinery.

» Replacements, a group which includes around fifteen distribution channels (for car,truck and motorcycle tyres), and whose importance differs from country to country.

In the real estate sector we have:

» Asset & Fund Management, whose customers consist of funds and property-owningcompanies in which Pirelli & C Real Estate generally has qualified minority share-holdings.

» Service companies, whose customers include, in addition to third parties, funds andproperty-owning companies and non-performing loans managed by the AssetManagement departments of Pirelli & C Real Estate.

» The Franchising Network, made up of affiliate agencies distributed throughout Italy.

Customers of Pirelli Broadband Solutions can be divided into the following categories for thebroadband access and photonics business areas:

Broadband Access (BBA) products:

» VARs (Value Added Resellers)

» System Integrators

» Telecom Operators

221


New-generation photonics products from the photonic business area:

» Operators/System Integrators (CWDM systems)

» Equipment Manufacturers (components and modules)

The companies under Pirelli Ambiente have the following categories of customer:

» Customers in the Renewable Energy sector, i.e. companies that convert urban solidwaste to energy.

» Customers in the Site Remediation sector, i.e. companies – mainly in the Group andother closely-related companies – that assess, plan and manage the demolition anddecontamination of buildings and/or lands.

» Customers of Pirelli Ambiente Eco Technology, i.e. companies that operate in publictransport, goods transport, waste collection, the mining sector and in construction.Pirelli Ambiente Eco Technology also operates through partners that are licensees ofits Gecam™ technology and which operate independently in Italy. In addition toreceiving royalties on its licensees’ sales, the company also (indirectly) performs thetechnical and marketing activities associated with the product.

DISTRIBUTION OF SALES BY GEOGRAPHIC AREA% on total number of customers % on total sales value

GEOGRAPHIC AREA Year 2006 Year 2006 Year 2005Italy 38% 27% 32%Rest of Europe 38% 33% 36%North America 2% 7% 7%Central and South America 13% 21% 17%Australia, Asia, Africa 9% 12% 8%

G R O U P P O L I C I E S

Customer orientation – a central element in the Values and Ethical Code of the Pirelli Group – pre-sumes a constant and ongoing commitment from Pirelli in terms of:

» Comprehension of the market context in which the Group operates

» Consideration of the impact of the Group’s actions and behaviour on the customer

» Exploiting every opportunity in doing business in order to satisfy the customer’sneeds

These principles are made explicit in articles 2 and 4 of the Pirelli Ethical Code. The relevantextracts are given below.

The companies of the Group:

» “pursue market excellence and competitiveness, offering customers a quality ofservice that effectively meets their requirements;” (from article 2, , of the EthicalCode - ‘Aims and Values’)

» “the excellence of the Group’s products and services is based on customer serviceand the readiness to meet customer needs. The aim is to offer immediate, thor-oughgoing and competent responses, tailored to the needs of customers, and inkeeping with the spirit of legality, courtesy and co-operation.” (article 4 , of theEthical Code - ‘Customers’)

222


The company’s commitments to the customer described above are similarly made explicit in theGeneral Conditions of Supply applied by the Group companies.

The great variety in the Group’s categories of customer means that there is an equally wide vari-ety of different methods for dialogue and interaction between the customers and the correspon-ding businesses. For the 2006 report, it was decided to present a case study of the relationsbetween the tyre sector and its customers, describing the quality management systems adoptedand the level of attention devoted to the customer’s “safety”.

F O C U S O N P I R E L L I T Y R E

M E T H O D S O F D I A L O G U E A N D I N T E R A C T I O N B E T W E E N P I R E L L I T Y R E

A N D I T S C U S T O M E R S

In addition to the daily contact with the sales organisation operating in the territories, customerrelations are handled by the Sales and Marketing departments, mainly via the following channelsand methods:

» Contact Center*

» B2B

» Periodic Customer Satisfaction Surveys* periodically carried out to evaluate the sat-isfaction level using the following methods: :

1. Mystery Survey* (except for Brazil and the USA)

2. Computer Aided Telephone Interviews* with mother-tongue operators

3. Pirelli DB (universe)

4. Survey of satisfaction scores (on a scale of 1-5)

The table shows the results of the surveys for the last 2 years:

Year 2005 Year 2006Overall satisfaction level (range: 1 - 5) 3.88 3.94Number of countries 11 13Sample - weight on total business 69% 80%

A T T E N T I O N T O Q U A L I T Y: C E R T I F I C A T I O N S A N D R E C O G N I T I O N

The attention given to quality by Pirelli Tyre, both as producer and as supplier, is demonstrated bythe certifications it has obtained, which conform to international standards and deal with aspectsof both the processes and the products and services offered to customers.

In particular:

ISO 9001

Pirelli Group has had a quality management system since 1970 and since then has gradually intro-duced it in all its plants. From 1993 onwards the Group obtained certification of its quality systemunder the ISO 9001 standard. Currently 100% of the factories are certified to the most recent edi-tion of this standard.

223


ISO/TS 16949

To meet the requirements of the car makers, from 1999 onwards Pirelli Group obtained certifica-tion for its quality management system under the ISO/TS 16949 standard, and has since maintainedits certification under the standard in force. All factories that supply the car makers have obtainedthis certification.

ISO/IEC 17025

In 1993, the Materials and Products and Outdoor Experimentation Lab of the Pirelli Group intro-duced a quality management system which is accredited under the ISO/IEC 17025 standard. Thisquality management system is maintained in conformance with the standard in force.

Pirelli’s car tyres are an excellent example of the company’s focus on quality, which is confirmedby Pirelli’s winning of a large number of product tests, and also by the company’s close links withsome very prestigious partners (famous car makers, specialist magazines, driving schools etc.) forproduct development and experimentation.

The table shown below gives the results of various different product tests on winter tyres, con-ducted by the leading specialist magazines:

224


P I R E L L I T Y R E ’ S C O M M I T M E N T T O C U S T O M E R S A F E T Y

Pirelli has always been foremost in pursuing product innovation to improve quality and safety forthe end consumer.

To achieve this, Pirelli Tyre avails of its close cooperative links with the leading car makers in amarket segment that is particularly thorough and demanding: the Ultra High Performance seg-ment, an area where Pirelli is the leading brand.

An example is the breakthrough K-PRESSURE OPTIC product. This innovative safety device wasdeveloped to simplify the life of the motorist by automatically taking care of a routine vehiclecheck that is often overlooked or underestimated in terms of safety value.

The K-PRESSURE OPTIC system is as intuitive as it is easy to use – no maintenance is required –which uses sensors inserted in place of the valve caps on tyres. These sensors clearly indicate,without the need for additional devices, if the pressure* in the tyres is correct or below the alertthreshold.

This ease of use means that motorists can devote all their concentration on driving, knowing thattheir tyres are at the correct pressure and that they only need to stop at a service station when itis actually necessary to inflate the tyre. Checking tyre pressure, which has always been regardedas “something only petrol-heads do” although it is essential for the everyday safety of all motorists,is transformed into a quick and easy everyday task: a glance at the colour of the valve is all that isneeded to dispel any doubts about tyre pressure.

Other innovative products introduced alongside K-PRESSURE OPTIC include:

» Run-flat or self-sealing tyres

» Specialist tyres for new types of vehicles and new uses, for example winter UHPtyres for ultra-high performance supercars for mixed road/track use, run-flat tyresfor SUVs etc.

» Tyres with increasingly low noise emission levels, for decreased environmentalimpact

» Materials that are innovative and advanced in terms of increasing compatibility withthe environment (for example the elimination of aromatic oils)

And it must not be forgotten that Pirelli assumes an active and direct role in the global increase inthe attention that motorists pay to tyres and, consequently, to their safety. This role is partly ful-filled by means of special advertising campaigns, such as the winter tyres campaign in Italy whichsaw Pirelli play an institutional role in the dissemination of information on the equivalence ofusing winter tyres and snow chains.

225


THE K-PRESSURE OPTIC SENSOR

2 . 4 . S U P P L I E R S

G R O U P P O L I C I E S

Pirelli Group maintains a sustainable approach to its suppliers. In this regard the Pirelli policy onHealth, Safety, Environment and Social Responsibility expressly states the company’s commit-ment “to establish and actively maintain the procedures to evaluate and select contractors andsubcontractors based on their commitment in the field of social and environmental responsi-bility.”

CSR has been integrated in both the General Conditions for Purchase of Goods and Services,applied by the company to its suppliers, and the phases of Vendor Approval and Vendor Rating, asdescribed in more detail below.

The purchasing processes are described in the Purchasing Manual. This document sets out guide-lines and procedures that are aimed at ensuring both transparency in internal processes and hon-esty in business dealings, and also integrity and contractual impartiality in relations between thecompany and its suppliers.

The purchasing processes have been reinforced by the development of new technologies (e.g.electronic auctions) that by their nature help enforce the measures for contractual transparencyput in place by Pirelli.

For the most important suppliers, the purchasing policies allow for long-term contracts, partner-ship contracts and, in some cases, shared growth strategies.

N E W G E N E R A L C O N D I T I O N S F O R P U R C H A S E O F G O O D S A N D S E R V I C E S

In 2006 Pirelli drew up its new General Conditions for Purchase of Goods and Services, whichwere to be introduced to all orders/tender contracts stipulated by the Group. This contractincludes some clauses that specifically refer to Pirelli’s Ethical Code and Policy for Health, Safety,Environment and Social Responsibility. The stipulation of a supply contract involves the suppli-er’s signing of these clauses, which commit the supplier to adopting behaviours at their companythat adheres to the content of the aforementioned ethical code and CSR policy. Pirelli also has theright to carry out audits to verify this adherence.

The new conditions are already applied to the Group’s Italian suppliers and they will be extendedto all foreign suppliers by the first months of 2007.

D I S T R I B U T I O N O F P U R C H A S E S B Y G E O G R A P H I C A R E A

The table below shows the geographical distribution of purchases, distinguishing between OECDand non-OECD countries. The table also gives the percentage weight of purchases made in eacharea over the total value of all purchases made.

DISTRIBUTION OF PURCHASES BY GEOGRAPHIC AREA% on total number of suppliers % ov total purchases value

GEOGRAPHIC AREA Year 2006 Year 2006 Year 2005OECD countries EUROPE 73.0% 63% 67%

NORTH AMERICA 4.0% 6% 9%OTHERS (1) 0.2% 2% 2%

Non-OECD LATIN AMERICA 19.2% 15% 11%ASIA 1.6% 12% 10%AFRICA 1.8% 2% 1%

(1) Australia, New Zealand, Japan and Korea

226


Over 80% of all purchases made by the entire Group are made up of goods and services purchasedby the tyre sector.

For this reason, for the 2006 sustainability report we decided to focus on Pirelli Tyre’s relation-ships with its suppliers.

F O C U S O N P I R E L L I T Y R E

The table below shows the distribution by type of goods and services purchased by Pirelli Tyre in2005-2006. The table also gives the percentage weight of purchases made in each area over thenumber of suppliers and over the total value of all purchases made.

DISTRIBUTION BY TYPE OF GOODS AND SERVICES PURCHASED BY TYRE SECTOR% of number of suppliers % of total value of purchases

TYPE Year 2006 Year 2005 Year 2006 Year 2005Raw materials 7% 8% 56% 37%Consumables 5% 5% 4% 4%Services 80% 78% 32% 30%Plant and equipment 8% 9% 8% 29%

D I A L O G U E A N D I N T E R A C T I O N B E T W E E N P I R E L L I T Y R E

A N D I T S S U P P L I E R S

Raw materials suppliers

Relations with suppliers are defined and enforced by specific company processes.

There are two fundamental underlying phases to supplier management:

1) Supplier approval (more commonly known as Vendor Approval)

2) Supplier monitoring (more commonly known as Vendor Rating)

The homologation process

The process of approving new suppliers of materials already in use or of new materials is gov-erned by the MP 063 Quality Standard, “Approval of materials for purchase and their vendors”.This interdepartmental process of approval follows definite and specific rules, and it concludeswith the addition of the approved material/vendor to the Vendor List. The Vendor List is the com-pany’s list of approved suppliers for each individual product.

The vendor rating process

The goal of the Vendor Rating process is to evaluate suppliers according to the following criteria:

» Quality of the product supplied or service provided

» Quality of commercial relations

» Technical/scientific cooperation

» Performance in terms of safety in the workplace, environmental responsibility andcorporate social responsibility

In 2007 the Pirelli CSR policies will be integrated into the Vendor Approval phase.

The process owner* of this interdepartmental activity is the Sector Purchasing Department, whichcirculates the Vendor Ratings to the suppliers every year.

227


The Vendor Rating is periodically reviewed and commented on by the Purchasing Department.This process involves meetings organised with the suppliers, the aim of which is to identify anycorrective action that may be regarded as necessary for improving results.

The procedures described above are followed by the entire Sector and are supported by a specialwebsite available on line via the Purchasing Portal. This website provides centralised support forsurveys, feedback and the definition of support actions. This provides both an assurance ofprocess uniformity and a guarantee of transparency, apart from being an excellent knowledgesharing tool.

M E A S U R E S A N D P R O C E S S E S A D O P T E D B Y P I R E L L I T Y R E I N 2 0 0 6

The processes of dialogue and interaction with suppliers are the object of continual processimprovement, both in qualitative terms and in terms of tools. Several measures and processeswere adopted by Pirelli Tyre in 2006 to improve the purchasing process, both internally and interms of supplier relations:

» Training courses have been developed on buyer professionalism (EIMP) and buyer-supplier relations

» A Purchasing Portal has been set up as a tool for communications and ongoing train-ing. All company standards and procedures (Purchasing Manual, Ethical Code) areavailable on the site, as well as the Vendor List and Vendor Ratings

» The main purchasing processes have been automated and linked to the company SAPplatform. These processes include raw materials requirements planning (MRP proj-ect) and the entire process governing requirements and supply of natural rubber,from the individual units to the purchasing centre in Singapore (PTE S’pore project)

» The order/delivery/invoice flow with suppliers have been automated by means ofWEB or HUB platforms (the RNC project), via EDI documents and document scan-ning

The above measures started in 2006 and their completion is projected for 2007 at all Pirelli Tyrefacilities worldwide.

228


3. ENVINRONMENTAL DIMENSION

3 . 1 . T H E P I R E L L I A P P R O A C H T O E N V I R O N M E N T A L M A N A G E M E N T

“Group companies believe in sustainable international growth in the common interest of all-stakeholders, both current and future. Their investment and business decisions therefore reflectrespect for the environment and public health. Without prejudice to compliance with specificprevailing legislation, Group companies are aware of the importance of environmental issueswhen making choices, not least in the adoption of specific technologies and manufacturingmethods (where this is technically feasible and economically viable) that allow for the reduc-tion of the environmental impact of their operations, even beyond the minimum limits setdown by regulatory requirements.” (article 7 of the Ethical Code - Environment)

Through the implementation of measures to apply the principles mentioned above, Pirelli Groupis achieving and reporting appreciable results. In particular, progress has been made in the follow-ing fields:

» Mitigation of the environmental impact resulting from the company’s own activities,products and services

» Rational use of natural resources and energy

» Promotion of a ‘culture of prevention’ with regard to pollution

» Conservation, development and appreciation of the territory

All this has been achieved despite the extremely wide and varied range of business areas that theGroup’s companies operate in, including:

» Manufacture of tyres for cars, industrial vehicles, goods transport vehicles, buses,motorcycles and steel cord, all produced by Pirelli Tyre

» Activities in the telephony sector, with products for photonics* and for broadbandinternet access (non-photonic), used to develop leading-edge innovative solutions forthe latest generation of telecommunications infrastructures: Pirelli BroadbandSolutions

» The real estate sector: Pirelli & C. Real Estate

» Environmental decontamination, waste-to-energy generation, and development ofalternative eco-compatible technologies (i.e. new fuels, innovative systems forexhaust gas abatement etc.): Pirelli Ambiente Holding

» Research and development in the fields of new materials and optoelectronic compo-nents: Pirelli Labs

In the sector in which it operates, each of the above companies invests the maximum possiblecare in responsible management of the environmental aspects of its activities, products and serv-ices, and of the environmental impacts associated with them.

229


Wherever possible, and particularly in the case of companies that have Production Units, PirelliGroup promotes the use of international reference standards for developing and implementingenvironmental management systems that are effective, efficient and aimed at continual improve-ment of its environmental performance.

The following sections describe in detail the main environmental aspects of the various differentsectors of the Group, together with the related initiatives undertaken by the companies involved.

3 . 2 . P I R E L L I T Y R E S . P. A .Pirelli Tyres engages in a vast range of activities, both in the production of tyres for cars, industri-al vehicles, goods transport vehicles, buses and motorcycles, and the production of steel cord (acomponent used mainly in the manufacture of tyres).

The company has 24 Production Units located in Europe, the US, Latin America, Asia and Africa.They are divided into two types of business units: tyre (for manufacturing tyres, as noted above)and steel cord.

The sections below analyse these two main business units separately, both in terms of productionand in terms of environmental aspects, impacts and indicators.

Pirelli Group is also a contributing member of the World Business Council for SustainableDevelopment (WBCSD), an association of 190 international companies distributed throughout 30countries that have made a voluntary commitment to unite economic growth with sustainabledevelopment.

Since 2005 the WBCSD has identified a list of global problems (e.g. the protection of ecosystemsand biodiversity, the promotion of sustainable production and consumption etc.). The inescapableresult of addressing these problems is the transformation of the currently-existing system of doingbusiness.

Pirelli’s active participation in the WBCSD has undoubtedly contributed to expanding the Group’sknowledge in terms of the methods it can use to achieve real sustainable development..

T H E E N V I R O N M E N T A L M A N A G E M E N T S Y S T E M *

The Policy for Health, Safety, Environment and Social Responsibility adopted by Pirelli Groupspecifies the definition and implementation of management systems that enable it to govern itsactivities, products and services based on internationally-recognised standards.

In the area of prevention of pollution, the ISO 14001* standard has been identified as the referencestandard for the environmental certification of management systems. In the area of health andsafety in the workplace, the reference standard chosen is the OHSAS 18001* standard (see the sec-tion dedicated to the description of this standard).

For Pirelli Group, certification of the environmental management system is something that essen-tially concerns the manufacturing activities of Pirelli Tyre S.p.A., which comprise the Group’smost important activities in terms of potential impacts on the environment.

Despite this, the same recognition has also been obtained by Group companies operating in theareas of design, research, logistics, and services, including the Tyre Test Track at Vizzola Ticino(Varese, Lombardy), and Pirelli & C. Real Estate Facility Management.

230


In the tyre and steel cord sector, of the 24 factories and facilities in the Group as at 31 December2006, 22 have implemented and obtained environmental certification of their management sys-tems.

The first certifications were obtained in November 1998 for the Brazilian factory in Santo Andréand the Turkish factory in Izmit.

Upcoming certifications are for the steel cord and tyre factories in Romania, which are currentlyin the development and startup phase.

The effort put in at Group level, to define common guidelines and procedures for the introductionof environmental management systems and their related ongoing maintenance and monitoringactivities, has further expanded the Group’s knowledge of environmental problems and its skillsfor their prevention and resolution and, in many cases, has paved the way for improvements inperformance with consequent mitigation of environmental impacts.

This positive trend can be seen in the tables and graphs given in the sections below on the vari-ous different companies of the Group.

In 2006 no environment-related incidents occurred with negative consequences for health or theenvironment. However, one tyre-making facility was fined euro 10,000 for an anomaly detected inits water discharges. At the time of going to press, the solution to this problem (proposed andagreed with the local authority) is nearing completion.

E N V I R O N M E N T A L C E R T I F I C AT I O N O F T H E V I Z Z O L A T I C I N O T E S T T R A C K

In addition to the Production Units, the company also has centres for carrying out scientific testsof tyre/vehicle performance. These centres conduct experiments and trials of tyres under variousdifferent conditions of use, using subjective and instrument controlled techniques.

Of these test centres one deserves particular mention: the test track located in the town of VizzolaTicino (in Varese province in Italy), which was designed and built at the end of the 1960s on a siteclose to the Ticino river. In early 2005 the track adopted an environmental management systemcertified under the UNI EN ISO 14001/2004 standard.

In addition to being used by the various Group companies for experiments and tests (in which itplays an essential role in researching the indirect environmental aspects associated with thedevelopment of new tyres and vehicles with reduced environmental impacts), the track is hometo sports events, driving schools, and motoring clubs, as well as being used by car manufacturersand trade magazines for joint tests and shows.

231


THE VIZZOLA TICINO TEST TRACK

The achievement of environmental certification by the Vizzola track takes on a special importancewhen we consider that its 26 hectares lie within the Parco Naturale Lombardo della Valle delTicino (Lombardy Ticino Valley Natural Park), an Italian nature reserve that is listed as a UNESCOMAB (Man and Biosphere) area – one of 425 biosphere reserves in 95 countries worldwide.

Implementing the environmental management system has enabled waste management optimisa-tion targets to be defined and achieved. Similarly, programmes spanning over several years havebeen set up and are currently underway to rehabilitate and redevelop the internal green areas withplantings of indigenous plant species, elimination of ozone depleting substances*, and support foruniversity programmes to develop vehicles with low environmental impacts.

Due to its special location in a protected area, the test track is in constant contact with the officesof the Municipality of Vizzola Ticino and of the Parco Naturale Lombardo della Valle del Ticino.

Through an agreement with the Park Administration, the test track contributes in economic termsto the environmental improvement of the external area. This work is carried out by the Parkauthorities.

H E A L T H , S A F E T Y A N D E N V I R O N M E N T D A T A M A N A G E M E N T

( “ H S E D M ” D A T A B A S E )

In parallel with the definition of specific common guidelines and procedures for drawing up andimplementing management systems in individual Production Units, the HSE Department hasmade a database available on the Pirelli company intranet. This database was developed usingweb-based logic, which allows enabled users to load data and related performance indicators andmake them available in real time. In addition to monitoring the performance (and therefore theobjectives) of each individual environmental management system, this database also enables theproduction of the document you are now reading, together with any other form of report thatbecomes necessary from time to time.

As in previous years, quantification of the equivalent emissions of greenhouse gases* (especiallyCO2 and NOx*) has been performed using conversion coefficients taken from the sources givenbelow:

ENERGY CONVERSION FACTORS FOR CO2 AND NOX EMISSIONSTYPE OF ENERGY Source Conversion factorNatural gas BUWAL 250 57.0 kg CO2/GJ

0.06 kg NOx/GJDiesel Idemat 2001 2983.3 kg CO2/t diesel

9.7 kg NOx/t dieselGPL Idemat 2001 2703.6 kg CO2/t GPL

13.2 kg NOx/t GPLFuel oil BUWAL 250 88.9 kg CO2/GJ

0.23 kg NOx/GJElectricity BUWAL 250 119 kg CO2/GJ

0.26 kg NOx/GJ

232


T Y R E P R O D U C T I O N

T H E C O M P O S I T I O N O F A S T A N D A R D T Y R E

A tyre may be seen as a compound or, in other words, a solid assemblage of materials with verydifferent properties, whose manufacture necessarily requires great precision.

Generally, we can define three distinct groups of raw materials::

» Raw materials that make up the compounds

» Raw materials that make up the structure of the tyre

» Auxiliary raw materials which, although they are used in the production process, donot form part of the finished tyre

The first group includes:

» Natural and synthetic rubbers

» Reinforcing fillers (in particular, carbon black)

» Plasticisers

» Ingredients for vulcanisation

» Protectors: anti-ageing and anti-ozonant agents

The second group includes:

» Brassed steel wire for the bead wires

» Steel cord for the metal ply

» Treated raw fabrics for the rubberised bonded fibre ply fabrics

Finally in the third group we have the “auxiliary process” materials (anti-adhesive agents, releas-ing agents, bonding agents etc.) and a series of auxiliary products specific to the various differentphases of the production process.

To better understand the environmental aspects of tyre production, the figure below shows across-section through an ‘average’ tyre and identifies the various different parts (known in theindustry as “semi-finished materials”) that make up the composite tyre.

233


(SOURCE: “LIFE CYCLE

ASSESSMENT OF AN AVERAGE

EUROPEAN CAR TYRE”,PRE CONSULTANTS B.V., 2001)

The following components are particularly important:

» Liner: a layer of synthetic rubber on the inside surface of the tyre. It is perfectlysealed and acts as air chamber.

» Carcass: the load-bearing structure of the tyre, this is made up of thin threads orplies in fabric fibre (up to 1,400 per tyre) set in a straight arc and rubberised. The car-cass is the key load-bearing element of the tyre since it withstands the pressure.

» Bead: a padding in the lower area (APEX), which transmits the motor torque and thebraking torque from the wheel rim to the ground contact area

» Bead wires: metal rings (two per tyre) made of one or more parallel rubberisedwires. The carcass plies are wrapped around the bead wires.

» Sidewalls: generally made of rubber strips that are extremely resistant to repeatedbending and oxidation. As well as absorbing some of the dynamic stresses that thetyre is subjected to, the sidewalls protect and reinforce the carcass.

» Belt layers: made up of plies, normally reinforced with very thin but highly resistantsteel wires. The belt layers are crossed over diagonally and glued together. Thecrossover of the belt wires with those of the carcass creates un-deformable triangles.

» Tread: the part of the tyre placed over the belts connecting the vehicle to the roadsurface. It is made by drawing and it has a trapezoidal shape, with the lower surfaceslightly hollow and shaped

P R O D U C T I O N P H A S E S

In general, tyre production follows the phases described below:

Compound preparation

The process begins with the production of compounds in the “compound room”, where large,fully-enclosed Banbury* mixers process the raw materials to correctly distribute the various dif-ferent ingredients within the finished compound.

Normally the compound is produced via two successive passes with the Banbury: the first passresults in a paste and the second pass results in the proper compound. The compounds used tomake tyres are blends of various different raw materials that undergo a processing technique thatdistributes them evenly throughout the treated mass.

Each raw material has a very specific function and it is added to the compound in well-definedproportions, in order to confer all the specific characteristics required on the finished product dur-ing operation.

Fabric rubberisation

Rubberisation of fibre and metal ply fabrics is done via a process of calendering (which consistsof applying two sheets of rubber on both sides of the fabric). This operation is carried out usingspecial machines called calenders.

The bonded fibre ply fabrics are normally purchased from third parties in pieces and then fed intothe fabric calenders, which perform the rubberisation.

234


Similarly, metal fabrics are made from steel cord enclosed in a sheet of compound by means ofspecial metal calenders.

Semi-finished products

Semi-finished materials are individual elements that are bonded together in the tyre-building phas-es. It is at this point that the tyre begins to take shape. Semi-finished materials can be classifiedinto groups, based on the type of processing they undergo (e.g. bead wires, drawn wires, fabricsetc.)

Tyre-building

Tyre-building is the phase where all the semi-finished materials are brought together to be bond-ed together and made into a tyre.

Tyre-building is normally separated into two successive phases. In the first phase, which is per-formed on a manual or automatic tyre-building machine, the end result is a carcass which is madeup of body-plies, bead wires and sidewalls.

Construction is completed in the second phase, which starting from the carcass made in the firstphase produces a carcass with dimensions and profiles that are similar to those of the finishedtyre. This is known as a “green” tyre.

Painting and vulcanisation

‘Painting’ is the name given to a phase of the process where an aqueous solution is sprayed insidea tyre that has just been made (a “green” tyre) to form a protective layer between the inside sur-face of the carcass and the vulcanising chamber. This is to prevent adhesion of the non-vulcanisedtyre when it is removed after the vulcanisation phase, which could result in pieces of rubber com-ing away from the tyre.

Vulcanisation is an irreversible process of transformation, obtained by increasing the temperatureand pressure to obtain the required shape and elasticity characteristics of the tyre.

Vulcanisation transforms the raw compound, with mainly plastic properties, into a vulcanisedcompound, with mainly elastic properties.

The vulcanisation process comes about as a result of a series of chemical reactions that progressover time and, accelerated by heat, modify the original molecular structure of the compound. Thetyres are vulcanised on special machines that use moulds to determine the final shape of the tyre.

Finishing

In the finishing phase the tyre undergoes a series of visual and instrumental checks to ensure thesafety and reliability of the tyres to be sold on the market..

235


T H E E N V I R O N M E N T A L I M P A C T O F T Y R E S

The environmental impact of production

To arrive at a truly complete picture of the environmental impact of producing tyres, we need towiden the sphere of analysis to include the entire life cycle of the product. One methodology fordoing this is described in the ISO 14040 standard (“Environmental management - Life CycleAssessment - Principles and framework”).

This approach was followed to analyse the life cycle of an average European car tyre. The analy-sis was carried out together with the major European tyre makers1, and the results allow us toidentify and quantify the major environmental impacts for each phase of the tyre’s existence – pro-duction, use, end of life, and everything in between.

The most interesting result of the study is the significant environmental impact associated withthe usage phase of the tyre which, for a ‘traditional’ tyre, accounts for 86% of the total impact.

On average tyres account for around 20% of the overall consumption of a car, and this partlyexplains the high environmental impact generated during its use.

On closer inspection of the impact generated during the usage phase, we can see that around 90%of this impact is due to fuel consumption resulting from friction between the tyre and the road sur-face, while the rest is due to the outcome of the friction (the so called tyre debris).

The above chart also highlights the contribution of the raw materials supply and productionstages, which together determine approximately 12% of the total impact (approx. 10% and 2%respectively).

The chart also shows a significant reduction in consumption (2.6%) in tyres containing silica com-pared to traditional tyres (whose main filler is only carbon black), resulting in an 11% reductionin the total environmental impact.

This has led to the development of new compounds for the tread (the part of the tyre responsiblefor the impact generated in the usage phase), containing silica instead of carbon black.

236


1 “Life Cycle Assessment

of an average European

Car Tyre”, PRè

Consultants B.V. on

behalf of BLIC, 2001.

This study is

representative of the

entire range of car tyres,

excluding snow tyres.

COMPARISON OF THE DISTRIBUTION

OF THE POTENTIAL ENVIRONMENTAL

IMPACTS OF TWO TYPE OF TYRES

The environmental impact of a tyre in the usage phase

To reduce the environmental impact associated with the use of a tyre, Pirelli Group is constantlycommitted to the research and development of new compounds and new product lines which,through the use of new materials, innovative internal structures and new tread designs, capableof reducing the rolling resistance* while ensuring the same tyre life.

Without doubt, the overriding priority of research and development is driver safety: the tyre mustensure proper vehicle control in the widest possible range of situations; however, due to theinevitable friction, it is also responsible for some of the vehicle’s fuel consumption.

In 2006 work continued on the optimisation of rolling resistance – the force that the tyre opposesagainst the advancement of the vehicle and which, together with wind resistance and the resist-ance offered by the mechanical components of the vehicle itself, influence fuel consumption and,consequently, the emission of exhaust gases per unit of distance travelled.

Rolling Resistance Index trend

The value of this parameter is obviously different for different types of tyre and it depends on aseries of factors such as the formulation of the tread compound, the inflated tyre pressure, thespeed and weight of the vehicle, the composition and state of the road surface, the ambient tem-perature, how the tyre itself is used, and so on.

In this context the ELRR (“Extra Low Rolling Resistance”) package has been available for someyears affecting all components of the tyre to obtain improvements in general tyre performance, aswell as further reductions in the rolling resistance.

237


RRc =

Rolling resistance

weight supported by the tyre

‘Newconcept’ tyre ‘Traditional’ tyre

Speed [km/h]

RR

c

As noted earlier, a small percentage of the total environmental impact is due to tyre debris, i.e.tyre particles worn away as a result of the friction between the tread and the road surface.

It has been estimated that during its life cycle, a tyre produces a quantity of tyre debris of between10 and 14% of its original weight.

The environmental impact of these particles is still being studied worldwide and Pirelli Groupplays its part in this international effort through the continual exchange of information and expe-rience with other tyre makers partecipating to the specific work group set up under the aegis ofthe World Business Council for Sustainable Development (mentioned above) via the ETRMA(European Tyre & Rubber Manufacturers’ Association).

Another environmental aspect of tyre usage is the noise generated by the tyre, which is studiedusing special software and by conducting experimental tests, both in the field and in special ane-choic chambers.

The chart below shows the difference in sound levels generated by a ‘traditional’ tyre and a mod-ern, new-generation tyre.

Noise level

238


GRANULOMETRIC FRACTION OF

UNDER 100 µm FROM THE

TYRE DEBRIS GENERATED BY A

TRUCK TYRE (LEFT)AND A CAR TYRE (RIGHT)

‘New concept’ tyre Traditional’ tyre

Speed [km/h]

dB

(A)

In addition to the research aimed at mitigating the environmental impacts directly connected withPirelli’s activities (particularly in the production phase), measures have also been put in place toreduce the impacts generated in the other phases of the tyre’s life cycle – phases that are only indi-rectly or partially related to the Group’s activities. Of special note are the selection of raw materi-als and the rational use of natural resources and energy.

Selection of raw materials: to reduce as far as possible the use of substances that are dangerous

» Systematic assessment of the eco-toxicological characteristics of any new chemicalbefore its introduction into the production cycle. In particular, following recentEuropean regulations on the classification, labelling and packaging of dangeroussubstances and preparations, Pirelli has updated the list of substances that cannot beused in its production processes, or for which research programmes are underway tofind a replacement.

In this regard, in 2006 approximately one hundred new raw materials have beenanalysed and assessed.

» Consolidation of the supplier evaluation system (more commonly known as VendorRating), based on concise quantitative criteria to assess the quality and level of serv-ice offered, including the supplier’s performance in terms of health, safety, environ-ment and social responsibility.

Rational use of natural resources and energy: here the principal results achieved are due to theprogress made in optimising the production of high-quality compounds using the CCM(Continuous Compound Mixing) system, and also the progressive consolidation of tyre produc-tion with MIRS

TM(Modular Integrated Robotized System).

The CCM process

The CCM process for producing com-pounds uses a 100% computer-controlledpneumatic distribution system to transportthe ingredients from their storage silos tothe twin-screw extruders working continu-ously.

The CCM technology was designed to man-age the complexity of the process derivingfrom the great many ingredients necessaryto produce the compound. The computer-controlled management results in improvedquality in the compound produced, and con-sequently in the finished tyre.

Via a specially-designed powder-captureand recycling system for solid materials,CCM technology has reduced dust levels inthe production areas to extremely low lev-els.

The CCM process also saves energy,enabling a reduction of approximately 20%of energy consumption per unit of product.

239


THE COMPOUND PRODUCTION PLANT USING

THE CCM PROCESS

The MIRSTM

MIRSTM is an integrated, modular robotic system for making tyres. It has a very high degree of flex-ibility due to its ability to optimise modularity and logistics.

240


VIEW OF A MIRSTM UNIT

(LEFT)THE MIRSTM

VULCANISATION PROCESS

(RIGHT)TYRES COMING OFF

THE PRODUCTION LINE

Compared to the traditional, large-scale tyre-building systems with their exceptionally high pro-duction rates, designed for customers in different geographic locations, the MIRSTM is a compactproduction ‘island’, flexible and easily programmable for extremely rapid adaptation to the pro-duction of new models. This system represents a real improvement, obviously in terms of technol-ogy but also in terms of logistics, since it can be easily located near the manufacturing processthat it serves.

In the MIRSTM process, tyres are built around a heated drum which is tailor-made for a particulartyre model. The drum is continuously rotated by a robot under an extrusion* device that distrib-utes the rubber over the surface.

The drum rotation and compound feeding movements are coordinated so as to arrive at the cor-rect distribution of materials to create the specific tyre model.

This new robotic process means real improvements in the quality of the product, since the geo-metric distribution of rubber fibres is extremely consistent over the tyre model.

End-of-life management of tyres

As noted above, a tyre’s end-of-life phase makes a small contribution to the overall environmentalimpact of the entire life-cycle of the tyre and, among the various final disposal options, burial inlandfill is by far the least desirable in terms of environmental compatibility.

For several years Pirelli Group has devoted considerable attention to research into the manage-ment of end of life tyres (ELTs), also in view of the Directive 1999/31/EC, which prohibits dispos-al in landfills of entire ELTs from 2003 onwards (and from July 2006, also fragmented ELTs).

This research has identified several different recycling opportunities for end of life tyres, both interms of recovering the raw materials that make up the tyres (‘material recovery’) and in terms ofrecovering the tyre in the form of fuel with a high heat value* (‘energy recovery’), as a valid alter-native to the use of fossil fuels.

AVERAGE CHARACTERISTICS OF END-OF-LIFE TYRES 1

Average valuesFerrous materials 15%Ashes 2%Fuel 81,5%Sulphur 1,5%Net heat value > 7,400 Kcal/KgVolatile matrials (of the fuel component) > 70%

1 U. Ghezzi, M. Giugliano, M. Grosso, S. Pollo, G. Zerbo “The use of tyres as fuel in a cement furnace”.

Thanks also to the commitment of Pirelli Labs a number of projects have been developed in thefields of recycling and energy recovery.

As the diagram below shows, the activities in question are focused on the recovery of materials(for example through granulation which, once the ‘textile’ and ‘metal’ fractions are separated, pro-vides a rubber granulate that may in turn be ground further to produce a finer powder).

241


Tyre recycling diagram

S U M M A R Y O F E N V I R O N M E N T A L P E R F O R M A N C E O F T Y R E P R O D U C T I O N

The figures given in this section are relative to the Production Units that manufacture tyres whichcome under the car, truck/agro and motorcycle business units.

Consumption figures for the factories in Yangzhou (People’s Republic of China) are not consid-ered, since these facilities are not yet fully operational.

242


Gaseous fuel

Carbon black

Solid fuel

Asphalt

Buildingmaterial

Acousticinsulationmaterial

Productsin rubberor plastic

Gasification

Pyrolysis

End-of-LifeTyre

Technology forcompound production

Sectioning

Granulation /Pulverization

In line with the sustainability reports of the last five years, the following factors and their environ-mental indicators are examined:

» Water consumption (expressed in m3/tonnefinished product)

» Energy consumption (expressed in GJ/tonnefinished product)

» Solvent consumption (expressed in kg/tonnefinished product)

» Waste production (expressed in kg/tonnefinished product)

» Equivalent emissions of CO2 and NOx (expressed in tonne/tonnefinished product andkg/tonnefinished product respectively)

» Presence of dielectric oils containing PCBs* and/or PCTs (with concentrations high-er than 50ppm)

» Presence of ozone depleting substances (in kg)

The calculation of the consumption figures given for each factor in the charts below takes intoaccount the increase in production over the year: from over 825,000 tonnes in 2005 to over 890,000tonnes produced in 2006 (an increase of approximately 7%).

As it can be seen from the charts below, almost all the indicators show perceptible trends ofimprovement. This can be ascribed to the implementation of environmental management systemsand to the effects of environmental investments, but it is also in no small part due to an increas-ingly attentive management of production. This last area is where the positive contribution madeby tyre production using the MIRSTM technology (described above) assumes particular impor-tance.

Consumption trends

Water procurement

243


Tyre productionWater specific consumption

(m3/tonnePF)

Energy consumption

Solvents1

Waste

244


1 For the 2006 data, the

criteria of Directive

1999/13/EC (“on the

limitation of emissions of

volatile organic

compounds* due to the

use of organic solvents in

certain activities and

installations”) have been

extended to cover sites

outside the EU. For

reasons of uniformity,

this approach has also

been used for 2005.

Tyre productionEnergy specific consumption

(GJ/tonnePF)

Tyre productionSolvent specific consumption

(kg/tonnePF)

Tyre productionWaste specific production

(kg/tonnePF)

Dielectric oils containing PCBs / PCTs 2

Ozone depleting substances

245


Tyre productionPresence of PCBs and/or PCTs

in conc. > 50 ppm (Kg)

Tyre productionOzone depleting

substances (Kg)

2 The values from 2001 to

2005 differ from the

values given in the

previous sustainability

report because a number

of transformers –

included in 2005, as a

precautionary measure,

in the transformers

containing oils with a

concentration of

PCBs/PCTs* higher than

50ppm – after detailed

analysis were found to

contain dielectric oils

with concentrations of

PCBs/PCTs lower than

50ppm.

Tyre productionWaste recycled (%)

Equivalent emissions of CO2 and NOx

S T E E L C O R D P R O D U C T I O N

Steel cord is mainly used in the production of tyres, in particular for making two semi-finishedproducts: metal fabrics and bead wires.

The five Operating Units managed by the Steel Cord Business Unit of Pirelli Tyre S.p.A. are locat-ed in Brazil, Germany, Italy, Turkey and Romania (a new factory).

The final products of the steel cord technological cycle (described in the next section) can bedivided into two main types:

» The actual steel cord, composed of several wires (drawn and brassed), for use instrengthening tyre structures

» A single drawn/brassed wire, for use in strengthening rubber tubes intended for highpressure use

For both products, the raw material is a steel wire rod (high carbon steel) with an initial diameterof approximately 5.5mm.

246


Tyre productionEquivalent emissions of CO2

(tonne/tonnePF)

Tyre productionEquivalent emissions of NOx

(kg/tonnePF)

T H E T E C H N O L O G I C A L C Y C L E

Although there are some minor differences between the various different operating units, the pro-cessing of steel rod wire can be adequately explained in the following 9 main phases, which referto the diagram on the following page:

a) Stripping and preparation: elimination of surface oxide flakes that form during thehot-rolling process in the steelworks.

b) First drawing: the prepared wire rod is reduced in diameter via cold drawing, usingsuitable lubricants (principally sodium stearate). The end products of this phase aredivided into thick wires (diameter of 2.5-3mm) and medium wires (diameter of 1-1.7mm).

c) Patenting for thick wires: patenting is a heat treatment which is necessary to restorethe wire’s structure and prepare it for a subsequent reduction by cold drawing. Theheat treatment is usually done in a furnace at a temperature of approximately1,000°C, followed by cooling down in molten lead at approximately 550°C.

d) Second drawing for thick wires: a cold deformation process similar to thatdescribed in phase b) above.

e) Patenting and brassing (for medium wires and for wires produced by phase d)above): In this phase, the patenting is similar to that described in phase c), and thebrassing process consists of depositing a very thin layer (2÷4mm) of brass (with azinc content of approximately 30%). This is necessary for the rubber compounds toadhere to the bead wires.

This phase consists of the following activities:

» Sulphuric electrolytic pickling

» Copper deposition in an alkaline bath

» Copper deposition in an acid bath

» Zinc deposition in an acid bath

» Thermal diffusion to obtain the brass alloy

» Phosphoric pickling

f) Third drawing: necessary to obtain wires with usable diameters (in general thesediameters are around 0.25mm). In this phase, both the wire and the die are immersedin lubricating baths made up of synthetic oils in water emulsion.

g) Stranding: the wires are assembled into strands, numbering from 2 to 10, which mayin turn be further assembled to make larger strands.

h) Cording: single wires and strands are assembled to make cords of varying complex-ity, geometry and number of components, depending on their intended use (in cartyres, truck tyres etc).

i) Testing and packaging: the product is subjected to tests and checks, both global andstatistical.

247


Diagram of steel cord production process

Q U A N T I TAT I V E D ATA F O R M E TA L C O R D P R O D U C T I O N

The figures given in this section are for the five Production Units that manufacture steel cord andwhich come under the Steel Cord business unit.

In line with the sustainability reports of the last five years, the following factors and their environ-mental indicators are examined for this business unit:

» Water consumption (expressed in m3/tonnefinished product)

» Energy consumption (expressed in GJ/tonnefinished product)

» Waste production (expressed in kg/tonnefinished product)

» Equivalent emissions of CO2 and NOx (expressed in tonne/tonnefinished productand kg/ton-nefinished product respectively)

» Presence of ozone depleting substances (in kg)

The results of the consumption figures for each environmental indicator* are given in the chartsbelow, and take into account the increase in production over the year: production rose by 5% overthe previous year, i.e. from over 137,000 tonnes in 2005 to over 144,000 tonnes produced in 2006.

248


Diagram of steel cord production process

Consumption trends

Water procurement

Energy consumption

249


Steel cord productionWater specific consumption

(m3/tonnePF)

Steel cord productionWater specific consumption

(GJ/tonnePF)

Waste

Dielectric oils containing PCBs/PCTs Not present in this business unit.

Ozone depleting substances

250


Steel cord productionWaste specific production

(Kg/tonnePF)

Steel cord productionWaste recycled (%)

Steel cord productionOzone depleting

substances (Kg)

Equivalent emissions of CO2 and NOx

E N V I R O N M E N T A L T A R G E T S O F P I R E L L I T Y R E

For 2006, the targets for environmental improvement set by the General Management of PirelliTyre S.p.A. were a decrease of 2% in energy consumption (excluding the Steel Cord business unit)and a decrease of 4% in water consumption (for the entire sector, including steel cord production).

These objectives have been comfortably achieved and, in particular, energy consumption has beenreduced by 5% while water consumption has been reduced by 4.9%.

The target for 2007 is to achieve further improvements in both of these parameters: 3% for the sec-tor as a whole.

251


Steel cord productionEquivalent emissions

of CO2 (tonne/tonnePF)

Steel cord productionEquivalent emissions

of NOx (Kg/tonnePF)

3 . 3 . P I R E L L I B R O A D B A N D S O L U T I O N S S . P. A .

Founded at the end of 2004, Pirelli Broadband Solutions operates in the research and developmentof advanced and innovative solutions for next-generation telecom infrastructures.

Supported by continual breakthroughs in technology from Pirelli Labs, Pirelli BroadbandSolutions activities are based on integrating competences in the fields of photonics, nanotechnol-ogy and broadband access systems, both wired and wireless.

PBS develops competitive and innovative solutions that enable telecom operators to offer voice,data and multimedia services with customised products and end-to-end platforms. The productsof Pirelli Broadband Solutions also enhance the increasing use of videoconferences and videocalls, which in their turn help to reduce staff movements, and so creating positive effects, bothdirect and indirect, for the environment.

In 2006 PBS took steps to bring its product portfolio and processes up to the standards requiredby European Directives 2002/95/EC - RoHS (Restriction of the use of Hazardous Substances) and2002/96/EC - WEEE (Waste of Electric and Electronic Equipment), reducing the presence of envi-ronmentally-damaging substances in its products and improving the product end-of-life manage-ment process.

In addition, in line with the Group’s policy and in order to assist and improve the management ofits environmental performance, the management of Pirelli Broadband Solutions has decided togovern its activities by adopting an Environmental Management System (EMS) in conformancewith the UNI EN ISO 14001 standard.

The programme to introduce this system is to begin in 2007.

3 . 4 . P I R E L L I & C . R E A L E S T A T E S . P. A .

Pirelli & C. Real Estate operates in a particularly dynamic arena whose perimeters are subject torapid changes. The company addresses its environmental aspects through three main activities.

The first is monitoring and reduction of the environmental impacts of activities in the company’ssites. The second consists of offering customers who are properties owners solutions designed toreduce the potential environmental impacts deriving from the running of those properties.

The third activity is the development of designs for new building projects, in which particularattention is paid to aspects of social, economic and environmental sustainability, while simultane-ously striving to preserve and enhance the territory in terms of attractiveness and competitivenesson a wider scale.

252


E N V I R O N M E N T A L I M P A C T S

Together with the obvious occupation and use of land, energy consumption represents one of themain origins of the environmental impacts generated by the company’s activities, products andservices.

Consequently, the principal measures for mitigating these impacts are aimed at saving energy. Forexample the company has adopted the use of district heating (central heating supplied by themunicipal electricity supplier, AEM, via a remote central heating system that produces hot andcold water and then distributes it via underground pipes). District heating now serves the entirehead office (HQ) in Milan, and is being considered as a solution for the second head office (HQ 2)currently being planned.

Another example of rational use of energy is the cogeneration plant at the administration centrein the Ivrea district, where Pirelli RE and other companies (Vodafone, Wind, Olivetti, Olivetti MSetc.) have their offices.

This cogeneration plant, which is owned by the Group and managed by Pirelli & C. Real EstateFacility Management, provides heat and electricity not only to Pirelli but also to other companiesthat have premises in the area. A similar solution is currently being installed in the Pozzuoli dis-trict.

Energy and water consumption for 2006 at the main sites of Pirelli RE and managed districts

Milan HQ Rome Naples Total Pozzuoli Ivea DistrictTOTAL CONSUMPTION site site District (3) (3) (4)Water (m3) 21,428 4,108 1,062 26,598 97,300 92,500Electricity (MWh) 4,175 1,002 256 5,433 22,080 4,349Fuel oil (Kg) (1) (2) (2) 661,314 -

1 Heat supplied by district heating system.2 Consumption not known because the building owner provides the heating and charges the cost as part of the rent.3 Other companies apart from Pirelli have premises in the district and therefore this figure does not apply to Pirelli Real

Estate activities alone.4 Figures for office building 1.

Rome Naples Pozzuoli IvreaSpecific consumption Milan HQ site site District Districtper m2 5 27,078 m2 7,000 m2 1,619 m2 57,000 m2 30,500 m2

Water (m3) 0.79 0.59 0.66 1.71 3.03Electricity (MWh) 0.15 0.14 0.16 0.39 0.14

5 Figures are for consumption per square metre because parts of the premises are occupied by other companies, for whichresource numbers are not known.

Waste production for 2006 at the main sites of Pirelli RE and managed districts

Rome Pozzuoli IvreaTOTTAL PRODUCTION Milan HQ site Total District 6 District 6

Non-hazardous (Kg) 31,515 3,410 34,925 21,220 11,112Hazardous (Kg) 500 938 1,438 593 7,596Total 32,015 4,348 36,363 21,813 18,708

6 Other companies apart from Pirelli have premises in the district and therefore this figure does not apply to Pirelli RealEstate activities alone.

253


E N V I R O N M E N TA L C E R T I F I C AT I O N O F P I R E L L I R E FA C I L I T Y M A N A G E M E N T

Among Group companies, Pirelli RE Facility Management has developed its environmental man-agement system in conformance with the ISO 14001 standard, for which it received certificationin 2002.

The process of certification covered the planning, coordination and provision of services for run-ning and maintaining buildings and systems, managing heating and air conditioning for public andprivate civil systems, and providing services for people, spaces and companies limited to the activ-ities conducted at the operations sites coordinated by the Milan office.

The management system involves approximately 150 persons in the operations department, whomanage around 250 buildings belonging to external customers, 40 belonging to Pirelli Group and1,250 sites belonging to Telecom Italia. Building management functions and services are providedpartly through the use of other suppliers.

The main objectives achieved in 2006 are in the following areas:

» Limitation of the possibility of spills occurring during transport of diesel

» Extension of the spill management procedure to all suppliers

» Administrative management of waste

» Purchase and development of software for energy assessment of property

» Assessment of the environmental aspects and impacts of the 10 most important prop-erties managed by the company

T E R R I T O R I A L D E V E L O P M E N T

Pirelli RE is one of the foremost Italian companies operating in the area of large-scale urban devel-opment projects (principally the redevelopment of disused areas). The company was a pioneer inthis area, and is responsible for some of the most important urban renewal programmes in Italy,as well as defining new standards at international level.

The company’s development projects are guided by a theory of urban development that centreson the concept of “metropolitan city” and which views the contemporary city as a poly-centric sys-tem. Each urban ‘pole’ or extreme is characterised by its own identity and independence, whilebeing at the same time perfectly integrated with its surrounding territory, and so overcomes frag-mentation and contrast between city centre and periphery.

In this light, the design phase of the urban environment takes on crucial importance calling forstrategic thought about social trends and dynamics: phenomena like globalisation, technologicalprogress, de-industrialisation, and multi-culturalism have brought about changes rapid and radi-cal enough to call for the rethinking of the very concept of “city” and its functions.

The following sections describe two projects drawing on the best practices internatinally avail-able.

254


T H E M A L A S P I N A P R O J E C T

The area of the Malaspina project is located on the outskirts of Milan. The Pirelli RE project, devel-oped as a joint venture with Aedes and Banca Antonveneta, has been devised with particularattention to well-being and quality of life, so that people can live and work in a lovely environmen-tal setting.

Residential areas and offices both overlook the Malaspina lake, in one of the biggest green areasin Lombardy, as part of a regional project called “Ten Big Forests for the Plain”, a breath of freshair and nature extending over a total area of 720,000 m2.

Residences 44,000 m2 of gross floor area (GFA)

Business Park 22,000 m2 of covered surfaces, 81,671 m2 of total build able, 80,850 m2 of greenareas

Parking areas 20,000 m2 of public parking, 54,115 m2 of private parking

Phase 2 of the Malaspina project has been designed and construction has begun. The buildings arebeing constructed in conformance with the European energy certification requirements for resi-dential properties and individual apartments, even though the provisions of Directive 2002/91/EC(“on the energy performance of buildings”) specify that this certification will not be compulsoryuntil July 2009 .

The certification specifies the annual amount of energy required to meet the needs associatedwith the standard use of the building, including winter heating and summer air conditioning, heat-ing of water for sanitary use, ventilation and illumination.

Phase 2 of the project has been improved over Phase 1: the insulation of the building shell hasbeen increased and the performance of the windows and doors has been improved, in order toraise the energy efficiency level from Class D (ranging from 70 to 90 kWh/m2year) to the upperlimit of Class B (ranging from 30 to 50 kWh/m2year).

255


THE MALASPINA PROJECT

Phase 3 of the Malaspina project has been designed in accordance with the requirements of ener-gy efficiency certification. The following sections explain the main design choices that impact onenergy savings:

Thermal cladding

The introduction of the so called thermal cladding increases the efficiency of the building shellinsulation, eliminating heat bridges almost completely. In terms of energy efficiency, this brings animprovement of around 10%, all other factors being equal. Installing the cladding does not involvechanges to the structural design; only minor construction details need to be introduced.Contracting and beginning construction do not need to be postponed.

Use of controlled ventilation

The project also features the use of a controlled ventilation system* to reduce the heat lost due tothe external air.

In a class B building the percentage of external air is over 30% of the total air flow and cannot bedesregarded.

Quality of door and window frames

Superior quality door and window frames are being installed in order to obtain low transmittance*levels. Transparent surfaces are in stratified double glazing. The overall transmittance of the doorsand windows is expected to drop from 2.3 W/m2 K to approx. 1.6 W/m2 K, allowing the occupantto maintain optimal internal levels of temperature and humidity in the apartment, allowing consid-erable energy savings at the same time.

These improvements also enable the building to approach energy efficiency class A, representinga further step towards high quality housing..

Moving from energy efficiency class B to A saves around 20 KWh/m2 per year which, for a 100 m2

apartment, corresponds to a saving of around 180-200 euros/year, and a reduction in CO2 emissionsof around 1 tonne/year.

256


ENERGY EFFICIENCY

CLASSES

H Q 2 - T H E ‘ H E A D Q U A R T E R S 2 ” P R O J E C T

Known as HQ2, this project is the extension of the head office of Pirelli Real Estate S.p.A. Theproject has several features aimed at achieving major objectives in terms of energy efficiency andthe use of renewable resources. The design criteria adopted are in line with current Italian legis-lation and with environmental sustainability criteria.

The façade

To minimise the use of artificial lighting, the windows will be located as close as possible to theceiling.

The south-facing side of the building will feature an interactive ventilated-module façade withshading curtains and external glass.

In order to reduce energy consumption for air-conditioning in summer and at the same time makethe maximum possible use of solar radiation in winter, the orientation of the Venetian blind shut-ter blades can be adjusted.

The north and east-facing sides will have a single-layer cladding façade and window framesdesigned to accept curtains that can be rolled up internally, but which – unlike traditional curtains– extend bottom up instead of top down, in order to take maximum advantage of available natu-ral light.

Particular attention has also been given to the non-transparent areas of the building shell, with theadoption of a layer of a 10cm-thick insulating material in front of the building structure, a venti-lated chamber and a lining in porcelain stoneware slabs.

257


THE HQ2 PROJECT

The air heating systems

The design of the heating systems allows energy needs to be controlled (this is in fact the princi-pal cause of energy waste).

The building will be heated by the district heating system, powered by the Milano–Tecnocitycogeneration plant.

The energy needs of the HQ2 building will be just over 1 million kWh, with a gross heated volumeof approx. 65,000m3. Taking into account the performance figures on heating systems, these val-ues imply a primary energy need (PEN) of 8.2 kWh/m3year, which is largely less than the minimumrequirements to be observed from 1 January 2010 onwards: 11.5 kWh/m3year.

Consequently, the energy savings that can be obtained stands at around 3.3 kWh/ m3 anno, whichimplies a reduction in CO2 emissions of around 100 tonnes/year (not to mention the economic sav-ings of around 21,000 euros/year in winter alone).

The project also enables reductions in consumption during summer as well, resulting in savingsof 20-30% referred to a standard building.

In order to make use as far as possible of renewable energy sources to meet energy requirements,the building will be equipped with a photovoltaic system to cover the roof of the main body of thebuilding.

As far as internal air conditioning, the building will be fitted with a system of ceiling radiating pan-els, allowing comfortable levels of heat/humidity.

3 . 5 . P I R E L L I & C . A M B I E N T E S . P. A .

A Pirelli Group company founded in early 2005 following the merging of Pirelli & C. Ambienteactivities with Cam Tecnologie, Pirelli Ambiente produces solutions for the environment and sus-tainable development and proposes to the market a vast range of products with low environmen-tal impact and high technological content.

Thanks to the synergies with Pirelli Labs – the Group’s advanced research centre –the company’songoing commitment is addressed to develop increasingly eco-compatible products and process-es and innovative solutions, e.g. technologies to reduce emissions of harmful gases, or in the fieldof renewable energy production, and materials science.

Pirelli Ambiente consists of three specialized companies, each dedicated to a different businessarea:

» Pirelli & C. Ambiente Renewable Energy – Renewable energy sources

» Pirelli & C. Ambiente Eco Technology – Technologies for sustainable development

» Pirelli & C. Ambiente Site Remediation – Environmental remediation

P I R E L L I & C . A M B I E N T E R E N E W A B L E E N E R G Y ( P A R E )

With regard to the recovery of energy from waste, Pirelli Ambiente Renewable Energy has devel-oped and patented – in collaboration with Pirelli Labs – a high quality WDF (Waste-Derived Fuel).

258


WDF-P in Italy

IDEA Granda is a consortium, 51% owned byACSR (Azienda Cuneese SmaltimentoRifiuti, a waste disposal company in Cuneo)and 49% owned by PARE, whose objective isto produce a high-quality fuel derived fromwaste (WDF-P) at its plant in Roccavione(Cuneo), using as its main raw material thedry fraction of the urban solid waste pro-duced by the 54 municipalities in CuneoProvince that have signed up to the ACSRconsortium.

The integrated system, centred around IDEAGranda envisages that the waste producedby the municipalities adhering to the ACSRconsortium, that was previously sent to theconsortium landfill in Borgo San Dalmazzo,is processed to separate the dry fractionfrom the humid fraction. The dry fraction isthen processed and enriched in the IDEAGranda plant to obtain high-quality CDR-P.

The actual energy recovery takes placewhen the fuel is burned in co-combustion atthe largest cement works in Italy, owned by

259


The fuel is obtained by adding to the dry portion of solid urban waste (S.U.W.) a number of components with a highcalorific power such as end-of-life tyres (ELTs) and non-chlorinated plastics.

It is mainly used for co-combustion as a partial replacement for conventional fossil fuels in existing energy generationand power stations, such as thermoelectric power stations and cement works.

The product, created using Pirelli Ambiente Tecnologie technology, is of a higher quality than fuels derived solely fromurban waste. Its distinctive features are:

• the product’s consistency and homogeneity;

• type of raw materials used;

• low humidity and chlorine content;

• high calorific rating;

• definition of the relations of mass;

• physical form of the fuel’s components, designed to smoothly feed a combustion chamber.

In addition to its formula enriched with end-of-life tyres(ELTs) and non-chlorinated plastics and the calorific stabilitythis entails, the fuel stands out for its contribution to improving emissions.

It is used to partially replace carbon in percentages varying between 10-25%.

The cost of generating electricity is a quarter of the cost of using biomasses.

All the projects promoted by Pirelli Ambiente Tecnologie based on the use of quality fuel quantify and analyse the envi-ronmental benefits involved by means of Life Cycle Assessment (LCA), which evaluates the entire manufacturingprocess and flows of materials and energy involved in each separate operation supporting the chosen technology.

VIEW OF IDEA GRANDA PLANT

IN ROCCAVIONE, CUNEO

WDF-P CHART

Buzzi Unicem Group and located in the nearby municipality of Robilante. WDF-P directly feedsthe main burner of two of the four furnaces in the plant, partly replacing the fossil fuel tradition-ally used.

The Integrated System

According to a study by the Bicocca University in Milan conducted using the Life CycleAssessment method, the IDEA Granda integrated system is, respectively, 90 and 72 times betterfor the environment than alternative solutions like landfills and waste-to-energy incinerators, witha percentage of energy recovery from waste of 32% in the area served, compared with an averagein Italy of 7% and a European average of 27%.

The use of WDF-P, in addition to contributing to the reduction of landfill waste disposal that todayafflicts all industrialised countries, is an ideal opportunity for high energy consuming industries(particularly cement works and thermoelectric power stations) that are now required to increasethe use of alternative energy sources over traditional fossil fuels, enabling them to make an impor-tant social contribution.

In the Buzzi Unicem cement works, use of WDF-P in 2006 resulted in a reduction of CO2 emissionsof over 30,000 tonnes into the atmosphere (each tonne of CDR-P used in co-combustion saves 1.75tonnes of CO2), making an important contribution to Italy’s objectives taken on for the KyotoProtocol*, and also a saving of over 20% of NOX emissions, or approximately 300 tonnes.Furthermore due to the biodegradable fraction contained in the fuel (approximately 50%), CDR-Pis recognised as a renewable energy source, and therefore eligible for the financial incentivesavailable for these sources.

PARE is also committed to the technical standardisation of waste-derived fuels, and contributesto the development and validation of technical specifications and analysis methods for solidrecovered fuels, for the purposes of their upcoming conversion to European standards.

WDF-P worldwide

In 2004 a study by the EEC (Earth Engineering Centre) in Columbia University gave its completeapproval for the use of PARE’s quality WDF in America, while a study conducted in 2005 by theIEFE (Institute of the Economics of Energy Sources) in the Bocconi University in Milan found itto be the cheapest renewable energy source available.

In 2005 Pirelli signed an agreement with the English company Re-Energy for the production andsale of WDF-P in the UK.

260


SUWA.C.S.R.

SUWPRETREATMENT

PLANT

DRY FRACTION

BUZZIUNICEM

CEMENT WORKSMAIN BURNER

WDF-P

NON-CHLORINATED PLASTICS ELTS AND RUBBER SCRAPS

IDEAGRANDA

HIGH-QUALITYFUEL PRODUCTION

PLANT

In 2006 the Clinton Global Initiative (CGI), a foundation set up by ex-US President William J.Clinton to collect resources to tackle the macro-problems faced by the planet, approved the PAREinitiative in the area of “climate change”. Through the spread of waste-to-energy technology, thePARE initiative aims to reduce CO2 emissions by 5 million tonnes over 3-5 years in North America,Europe and Asia.

P I R E L L I & C . A M B I E N T E E C O T E C H N O L O G Y –T E C N O L O G I E S F O R S U S T A I N A B L E D E V E L O P M E N T

GECAM, the White Diesel™

Pirelli & C. Ambiente Eco Technology operates with considerable success in the sustainable devel-opment technology sector, thanks to Cam Tecnologie’s long lasting experience in low environmen-tal impact fuels with GECAM, the white diesel™ and in antiparticulate filter technology with theFeelpure™ filtering system. The GECAM™, patented by the Group, reduces the pollutant emis-sions typical of diesel oil (fine particulates, carbon monoxide and nitrogen oxides*).

GECAM™ is an emulsion of water (10%) in diesel oil which is usable by diesel-powered vehiclesand in power stations. The presence of water ensures a more complete combustion of the hydro-carbon, reducing the formation of particulate and improving the consumption efficiency.Furthermore, GECAM™ lowers the temperature in the combustion chamber, and reduces the for-mation of nitrogen oxides.

Many centres of excellence in the field of research and certification of engines and emissions haveverified the environmental benefits of emulsions. In particular, the tests performed on GECAM™by the European Commission Joint Research Centre in Ispra and Eni Tecnologie laboratoriesshowed reductions of over 50% in emissions of particulates, 5-6% in nitrogen oxides, and over 30%in carbon monoxide.

261


1 ULSD = Ultra Low

Sulphur Diesel

11

LOGO OF CLINTON GLOBAL

INITIATIVE

Pirelli & C. Ambiente Eco Technology received a Special Award for the GECAM™ emulsifieddiesel and its innovative solutions in sustainable transport, at the 2006 World Renewable EnergyCongress (WREC), an international conference held by the University of Florence and the ABITACentre (Architecture, Bioecology and Technological Innovation for the Environment).

Feelpure™

Feelpure™ is an exhaust gas treatment system for diesel vehicles already in circulation (via retro-fit) with a mass of over 2.5 tonnes. Feelpure™ is made up of three elements:

1. A particulate filter in porous silicon carbide (SiC) fitted in a stainless steel caninside the exhaust silencer.

2. An additive to be added to ordinary fuel, which allows for the complete combustionof the carbonaceous particulate previously trapped by the filter (a process of regen-eration).

3. A control unit that monitors the entire system: this detects counterpressure at theexhaust and the exceeding of alarm thresholds. It doses the additive to be added tothe fuel on vehicles with this kind of feature.

Recent tests, conducted by Eni Tecnologie Laboratories, the European Commission JointResearch Centre in Ispra and the University of Biel under the VERT programme, have shownreductions of over 90% in mass particulate and 99% in finer particles, over 90% in carbon monox-ide and up to 69% of unburned hydrocarbons.

Nowadays several hundred buses in Italy are using the Feelpure™ filter system and more systemsare being installed on earth-moving vehicles, heavy transport vehicles, diesel trains and electrici-ty generators.

262


Gecam, the white diesel™ is an environmentally-friendly fuel, patented by the Group, that is capable of reducing

particulates by 50%.

It is a an emulsion of water (10%) in diesel oil for use in vehicles and heating systems:

– largely adopted by over 10,000 diesel-powered vehicles (buses, lorries, diesel trains, street-cleaning vehi-

cles, waste collection and earth-moving vehicles) and over 400 public and private buildings

– available at a lower price than traditional diesel, such as to reduce operating costs

– tested by Eni Tecnologie Laboratories, by the European Commission Joint Research Centre in Ispra, by

the main engines and burners makers, by the Municipality of Milan in cooperation with the Experimental

Fuel Station (SSC, Stazione Sperimentale per i Combustibili) and by SGS Ecologia

– available throughout Italy from 8 production sites and also in France and in the Czech Republic

– assists and improves the performance of particulate filtering systems in terms of emissions of PM and NOX

GECAMTM CHART

In 2005 Pirelli & C. Ambiente Eco Technology was awarded the Premio all’Innovazione Amicadell’Ambiente (Friend of the Environment Innovation Award) by Italian environmental associationLegambiente together with the Lombardy Region Council.

263


Feelpure™ is an exhaust gas treatment system for diesel vehicles already in circulation (via retrofit). The Feelpure™

system can reduce particulates by over 90%.

The filtering system developed by Pirelli Ambiente Eco Technology:

– Contains a silicon carbide filter (SiC).

– Uses an organometallic additive molted in the fuel, which is necessary to regenerate the filter.

– Can be adapted to all engine types – from Euro 0 to Euro 4 – running on fuels with normal sulphur content.

– Can be used on buses, trucks, earth-moving vehicles (quarries, building sites, tunnels), diesel trains and elec-

tricity generators.

– Has been tested by Eni Tecnologie Laboratories, the European Commission Joint Research Centre JRC in

Ispra and the TTM-University of Biel under the VERT qualification programme.

– Unlike other technologies on the market, the Feelpure™ filtering system does not result in increased emis-

sions of NO2 (nitrogen dioxide), a dangerous pollutant with negative effects on health and which is on the

rise in our cities.

FEELPURETM CHART

P I R E L L I & C. A M B I E N T E S I T E R E M E D I AT I O N S.P.A .E N V I R O N M E N TA L R E M E D AT I O N

The initial experience gained by Pirelli & C. Ambiente Site Remediation S.p.A. in environmentalremediation was the redevelopment of Pirelli Group’s historical industrial site in the Bicocca areain Milan in the early 1990s.

Over the years the company has widened its expertise by providing support to other companies inthe Pirelli Group in the management of industrial areas throughout Italy, as well as providing sup-port to Pirelli & C. RE in the acquisition and environmental remediation of new disused areasand/or property assets.

Pirelli & C. Ambiente Site Remediation has gained considerable experience in the remediation ofdisused industrial sites and offers a complete management service that includes all phases of theprocess, from the preliminary assessment of environmental liabilities (Environmental DueDiligence*) of property assets and/or sites that may require property broking services, to thedevelopment of the necessary engineering activities and management of relations with the rele-vant authorities through to complete redevelopment and valorization of the areas, with respect tothe environmental aspects, timing and specific customer requirements..

Whenever possible, remediation operations make use of on-site decontamination systems (e.g.bioremediation) or in situ systems (e.g. bioventing), to reduce the volume of contaminated mate-rials for disposal.

In situations where site remediation has required the excavation of contaminated materials, toreduce the overall volume of waste to be disposed off, the following activities have been carriedout:

» Enhanced characterisation during the investigation phase, to best determine thecharacteristics of the soil to be dug up

» Riddling and separation of the fine fractions, for best reuse of uncontaminated mate-rials on-site

» Enhanced characterisation of the soil to be sent to landfill

» Complete on-site recovery of materials originating from demolitions

The following table shows the extent of the work carried out by Pirelli & C. Ambiente SiteRemediation to date:

Total surface area redeveloped or undergoing redevelopment approx. 3,000,000 square metresBuildings demolished approx. 3,800,000 cubic metresMaterial salvaged from demolition work approx. 800,000 cubic metresEarth dug up and processed for remediation approx. 1,700,000 cubic metreslarge-scale remediation projects via on-site remediation 4large-scale remediation projects involving site safety 4

264


3 . 6 . P I R E L L I L A B S S . P. A .

Founded in May 2001 with an overall investment of 135 million Euros, Pirelli Labs represents thePirelli Group’s pole of technological excellence.

The research centre, extending for around 13,000 m2 in the Milan Bicocca area , is active in thefields of photonics and new materials.

Organised into three departments – Optical Innovation, Material Innovation and ProcessInnovation – Pirelli Labs represents the point of reference for all Pirelli research activities world-wide and is directly linked to the research centres of the group’s business units and also with lead-ing privately-owned and university research centres in the US, Russia and Italy.

In 2006 Pirelli Labs continued its research into the development of components (membranes andelectrodes) for fuel cells*, which are an ideal solution for producing electricity at a time when fos-sil fuels are coming ander increasing pressure and there is a growing demand for clean energysources to reduce emissions of greenhouse gases.

Development work continues to be focused of SOFC (Solid Oxide Fuel Cells) and PEM (PolymerElectrolyte Membrane), concentrating on the optimisation of components for small-scale cells(max 1000 W) for powering mobile electronic devices and for cathodic protection of gas transportlines.

Results obtained in the synthesis of ceramic materials and their miniaturisation have been appliedin the manufacture of electrodes for SOFC, as part of the cooperation with the prestigious AlbertaResearch Council (ARC) in Canada. The combination of the fuel cell miniaturisation technologydeveloped by the ARC with the electrodes made from innovative materials developed at PirelliLabs has resulted in efficient cathodic protection devices to be used on transcontinental gaspipelines in North America.

Unlike products already on the market, which are made from fluoridated polymers, the PEM mem-brane developed by Pirelli Labs has the capacity to operate at high concentrations of methanol,the fuel envisaged for use in consumer portable electronic devices.

These characteristics have been evaluated by the major players in the world market for fuel cells.Samples of the material were provided to these companies for evaluation of their performance ascomponents in the main applications for mobile electronics. The outcome of these evaluationswas positive and has led one major player to begin a joint programme of evaluation and develop-ment of the Pirelli Labs membrane, aimed at creating a next-generation industrial reference.

In the field of hydrogen-powered fuel cells, the technological development of a membrane hasbeen completed and a technical/economic assessment of production scale up* of this material hasbeen completed.

Pirelli Labs continued its research into the development of applications based on the recovery ofend-of-life tyres (ELTs). Of particular note is the initial industrial development of productsobtained by mixing ELT granules with suitable bonding materials and so producing materials idealfor reducing footstep noise. A number of pilot sites have been identified and large-scale (over1,000 m2) trial installations performed in premium residential buildings.

Field tests have confirmed the product’s noteworthy features, especially in terms of economy andease of laying, while acoustic tests, conducted by an accredited laboratory in accordance with theISO 140/7 standard, returned noise reduction values better than current market standards.

2006 saw the conclusion of another major development programme of great importance in termsof environmental impact. Pirelli Labs has developed poles for telecommunications networks,made of a composite material of recycled polypropylene and fibreglass. These poles will replacecurrent wooden poles impregnated (to provide resistance to environmental agents) with CCA

265


A PIRELLI LABS TECHNICIAN

(Chrome Copper Arsenic) compounds, now banned by the European Union. The cost benefit ofthe product has been demonstrated and a sound process has been implemented to make thesenew poles both competitive with older wooden poles and largely cheaper than fibre glass poles.

In 2006 progress was recorded in the joint research programme with Telecom Italia, involving thestudy of innovative materials suitable for use in radiofrequency devices for telecommunicationapplications.

In this particular field is worth mentioning the so called Telemedicine Project carried out withimportant international partners provides experts with innovative means of checking key medicalparameters of non-hospitalised patients, without requiring them to change their usual lifestyle.

The project, through the field trial phase has demonstrated its applicability and reliability on a sig-nificant sample of patients and it has attracted significant interest from the medical community.

In the field of renewable energy, of note is the experimentation with a series of innovative proto-types based on photovoltaic concentration technology aimed at direct field evaluation of the effi-ciency of these systems compared with conventional systems made of flat panels in crystalline sil-icon.

266


4. SOCIAL DIMENSION

4 . 1 . I N T E R N A L C O M M U N I T Y

Group companies recognize the central importance of human resources in the belief that the keyto the success of any business is the professional contribution of the people that work for it, ina climate of fairness and mutual trust. Group companies shall safeguard health and safety inthe workplace and consider respect for workers’ rights as fundamental to the business.Working relationships are managed with a view to guaranteeing equal opportunities and pro-moting the personal development of each employee. (Article 6 of the Ethical Code – HumanResources).

T H E F I G U R E S - B R E A K D O W N O F H E A D C O U N T

Haedcount breakdown by sectors as at December 31th, 2006:

BREAKDOWN OF EMPLOYEES ON 12.31.2006Corporate1 Tyres Real Estate PBS Ambiente Total

Executives 89 210 194 15 9 517Staff 1262 4946 1401 145 41 7795Blue-collar 15 20013 269 6 2 20305Total 1366 25169 1864 166 52 28617

∆∆ 2006 Vs 2005 Corporate1

Tyres Real Estate PBS Ambiente TotalExecutives (16) 22 28 4 1 39Steff 15 246 256 41 7 565Blue-collar (8) 1228 (34) (1) 1 1186Total (9) 1496 250 44 9 1790

Geographical breakdown by sectors as at December 31th, 2006:

GEOGRAPHICAL BREAKDOWN OF EMPLOYEES ON 12.31.2006Corporate

1Tyres Real Estate PBS Ambiente Total

Europe 1349 12993 1864 166 52 16424North America - 265 - - - 265Latin America 16 9786 - - - 9802Asia, Africa and Oceania 1 2125 - - - 2126

∆∆2006 VS 2005Corporate1 Tyres Real Estate PBS Ambiente Total

Europe 2 332 250 44 9 637North America (14) 39 - - - 25Latin America 3 663 - - - 666Asia, Africa and Oceania = 462 - - - 462

1 Pirelli & C. SpA, SSC, Pirelli Labs, PISEFI, CSAP, SAP, Polo Viaggi, Foreign Corporate Companies

267


Type of employment contract as at December 31th, 2006 and comparison of 2006 vs 2005:

TYPE OF EMPLOYMENT CONTRACT 2006 VS 2005Permanent 87.9% (0.5%)Fixed term 9.4% 0.6%Agency workers 2.7% (0.1%)Part-time (% on total of FTE*) 0.8% 0.1%Stage / Other 4 543 (72)

4 Non included in total employees.

Employment flows as at December 31th, 2006:

EMPLOYMENT FLOWS ON 12/31/2006 5

New Hiings 5016Employee Leavings 3156Average length of service (years):

Executives 10Staff (cadres included) 10Blue-collar 9

5 Not including people involved in corporate acquisitions or assignments of companies or of company branches.

The Group’s workforce trend is characterised by consistent growth (+1790 employees), comparedto the previous year. This increase especially results from the tyre sector’s hiring of personnel tostrengthen the new industrial plants in China and Romania, the increased labour workforce inBrazil subsequent to changes in the Campinas factory’s work pattern and the increased produc-tion volumes in the Feira de Santana and Gravatai factories. An addition of 250 employees wasrecorded in Pirelli & C. RE due to the consolidation of the Credit Servicing Company.

Concerning the movements of incoming and outgoing personnel, we must take the issue of sea-sonal work into account - a typical phenomenon in the tyre sector that requires temporary work-ers to stand in for permanent workers (approx. 700 people between Germany and Turkey) tomaintain production volumes constant during the summer months.

The group does not employ anybody under the age of 14.

The tyre sector employs 45 young workers aged between 16 and 18 years (26 in Brazil, 4 in UK and15 in Germany) and as an exception 18 young workers aged between 14 and 16 years in Brazil, aspart of training and induction schemes in line with local laws.

H R 6 P O L I C I E S

To steer the crucial phases of integration and development of human resources, the Pirelli Groupapplies an extensive policy system on both a group (Corporate initiatives) and Sector/foreign affil-iate Company level.

Salary Review policies are locally applied by individual countries except for procedures involv-ing Executives worldwide and key resources involved in international mobility schemes, sincethese categories are centrally coordinated by the Group’s Parent Company according to a com-mon rationale and always respecting the requirements of an international Management team. In2006 a Development Centre phase coordinated by the Group’s Parent Company and focused on

268


6 Human Resources

objectively evaluating the potential of individual candidates was introduced to the assignmentprocess of new executives.

Policies concerning Performance Assessment/Improvement are closely linked to salary reviewpolicies.

100% of Executives and 50% of Cadres take part in the Group’s annual incentive scheme (MBO),which sets clear Group/Business and individual economic-financial targets and pays out bonusesvarying according to assessment and the extent to which the said targets are achieved.

An important project is geared towards relaunching of an assessment and performance refiningsystem (referred to as Performance Management), aimed at improving the relations betweemmanagers and thei staff. This system will be launched en masse in 2007, in the whole Group.

In 2006 Pirelli Tyre launched a worldwide project to map the skills of key resources in the Sales,Industrial and Quality Departments. The programme was geared towards creating a common plat-form to start planning and implementing dedicated training tracks and compensation and devel-opment actions along common lines and coordinated by the sector.

The International Mobility policy, which bears witness to the international framework’s strate-gic value in the development of leadership within the Pirelli Group, deserves special focus and vis-ibility.

Over the past ten years, an average of approx. 250 people, numbering executives, cadres and staffof various nationalities and cultures, have yearly compared notes, developed professional skillsand made the most of new managerial opportunities, thus contributing to build a truly internation-al Group.

Many features of the new global labour market have triggered the need to define a more flexibleapproach to the international framework to speedily meet both the organisation’s requirementsand the needs of individuals who work therein.

The new policy provides flexible answers to requests/demands that were once perceived as anobstacle to international mobility, i.e. dual careers (considering the partner’s work-related/person-al needs), family requirements, different schooling systems, etc.

Over the past 5 years the maximum duration of foreign travel has, for instance, been reduced from5 to 3 years, thus enhancing the rotation of personnel in the Group’s developing/strategic sites,while concurrently meeting family requirements and the issue of dual careers. The option of com-muting (widely chosen especially in Europe, this involves a Monday to Friday routine and a rela-tively close location to enable an easy weekly return to the country of origin) has also been intro-duced.

Job transfers abroad and missions are still the most widely used methods.

Lastly, international mobility perceived as a real development opportunity can be fully consideredas a supporting tool in the Group’s Equal Opportunities project. At the close of 2006 the percent-age of women on the total number of personnel transferred abroad was approx. 15% (slightly high-er than the previous year). We believe this percentage, thanks to the grater flexibility adoptedtools, is set to increase in the near future.

T H E G R O U P ’ S E Q U A L O P P O R T U N I T I E S P R O J E C T

The Group’s Equal Opportunities Project was begun in 2005, in compliance with the principle“...to ensure equal opportunity and to, promote the development of each individual” declared inthe aforementioned Policy for Health, Safety, Environment and Social Responsibility and to imple-

269


ment provisions in art. 6 of the Group’s Ethical Code, in the section that says “....Working rela-tionships are managed with a view to guaranteeing equal opportunities and promoting the per-sonal development of each employee”.

The goal of the Project is to guarantee equal opportunities for professional growth in all companyfunctions and environments, thus enabling the entire Company to manage the “diversity” issue inan effective and cutting-edge manner as it strives to achieve its business goals.

From an organisational perspective, in 2005 the Project involved the appointment of an EqualOpportunities Steering Committee, a high standing body appointed to direct and safeguard cor-porate plans on the issue of equal opportunities. A Group Equal Opportunities Manager was con-currently appointed to direct the Project’s operational implementation inside the Group, to pursuegreater organisational balance and to monitor the progress of equal opportunities in all Affiliates.

The organisational framework was completed in 2006, when Country Equal OpportunitiesManagers were appointed to locally direct and monitor the progress of equal opportunities.

2006 also witnessed the early stage of communication of the project content.

The first step in this direction consisted in drafting and publishing the Group Equal OpportunitiesStatement (already mentioned in the first chapter of present sustainability section).

Translated into the 11 main languages commonly spoken in our Group, this statement has alreadybeen conveyed to all employees - both electronically and in hard copy - with an introductory notesigned by the Chairman. The Document is published in the Pirelli Group’s website and can beaccessed by the external community in the “Sustainability” area.

The second initiative involved the draft of a leaflet describing the project’s most relevant contents.This too has been translated into the main languages spoken by Group employees and is current-ly being distributed. Distribution will be completed in 2007.

Concerning contents, the Project envisages the Group’s commitment in two main action areas: thefirst is human resources management, which is increasingly inspired by the principle of makingthe most of differences and guaranteeing equal opportunities for professional growth; and the sec-ond concerns a greater care on work-life balance issue, with a view to facilitating the reconcilia-tion of the professional/private lives of company employees.

It is clear that the first area is a challenge that presumes the specific intention to really influencecorporate mentality.

To this end, the Company has undertaken to implement specific “positive actions” for selecting,developing and training human resources.

In particular, the screening and development framework aims to:

» Establish a joint male-female short list as a basis for the selection process for alltypes of personnel search geared to the placement of said personnel at any level ofthe organisation.

» Promote tailor-made measures in functional areas that most lack balance

» Guarantee equal access opportunities to training initiatives, international mobilityprogrammes, promotions and new responsibilities

» Guarantee the principle of equal opportunities in all analysis and assessment phasesrelated to career tracks

» Implement local periodical control processes for the abovementioned actionsthroughout the different affiliates.

270


Training will be the tool aimed at raising awareness within the organisation as regards the issueof acknowledging and valorising diversity. encouraging personnel to really shoulder their respon-sibilities concerning the abovementioned topics.

The second action area, which is closely related to the typical socio–economic frameworks ofindividual countries where the Group operates involves corporate commitment to pay more heedto demands that may surface from time to time. Initiatives that can both influence working hoursand support to employees’ families have, for instance, been theorised.

The Internal Equal Opportunities Complaint Procedures – designed to totally defend the princi-ples of equal opportunities announced by the Statement and to be implemented in all Group affil-iates – reached the final drafting stage at the close of 2006. They will be enforced in all affiliatesin 2007, consistently with local regulations.

Concerning the subdivision of headcount by gender, figures as at December 31th 2006 show anapprox. 20% (vs. 17% in 2005) incidence of females holding managerial functions, 36% (same as2005) of females in staff functions and 3% (vs. 2% recorded in 2005) in the labour group. Dynamicshave improved, compared to last year, due to the natural course of events, since specific positiveactions targeted at promoting /increasing female presence both in the areas that most lack balanceand in managerial/leading posts will be launched in 2007.

Another aspect of equality of treatment that the company seeks to ensure and monitor group-wide is that of remuneration.

In this regard and as already recorded in the 2005 Sustainability Report, basically equal salary con-ditions for men and women have been confirmed at all organisational levels (i.e. executives,cadres and staff).

E M P L O Y E R B R A N D I N G * A N D S E L E C T I O NTalent attraction initiatives tools*

To control the crucial phases of the human resource integration and growth process, the PirelliGroup applies an extensive system of policies both as Group (corporate initiatives) and in the var-ious sectors/foreign affiliates.

Policies that define and regulate the Personnel Research & Selection process are locally appliedby affiliate companies, consistently with currently enforced practices and local regulations. InItaly, for instance, the screening mode adopted for recent graduates is centralised and managedby the HR Department during the first stage of CV sourcing and screening . Later and with the col-laboration of a specialized external company an assessment phase takes place, based on Groupdynamics, tests and individual interviews; finally probing cognitive interviews are directly carriedout with the Line Manager who is assisted by the HR Department. Positively evaluated candidatesare integrated in the Company through a training and orientation track.

Talent Attraction initiatives through which the Group expresses itself include:

» Employer Branding: choice of reference universities/faculties/Master’s Degreecourses in leading universities in Italy, Romania, China and Brazil – the Group’s inter-national development centres; than brand management and Pirelli’s presence therethrough contacts, corporate presentations, case hystories, practical training sessionsand recruitment days held by the HR Department with the Line Managers from thevarious departments/business areas.

This activity has lead in 2006 to an increased number of candidates, recording forinstance an average 600 a month in Italy.

271


» Career Days: this international job meeting network envisages a cycle of eventsthat yearly involve some of the leading university cities, thus enabling Pirelli todirectly meet graduates, under-graduates and young professionals. Pirelli considersparticipation in such events an important employer branding tool. In 2006 Pirelli hadits own stand at universities in Milan (Bocconi University, Polytechnic, Bicocca),Pavia, Turin and Naples.

» Career Books: this is a career service for work orientation, post-graduate training,recruitment and communication targeted at undergraduates, recent graduates andyoung professionals. These guide-books are organised into three sections – post-graduate orientation, company profile (which describes the corporate profile,screening procedures, career tracks and has a brief section on CV presentation) andtraining – and are distributed in placement offices in universities, orientation offices,internship programmes, associations for graduates, bookshops and during CareerDays.

In this framework Real Estate has started an integration and “job rotation” programme calledCampus Project for twelve recent graduates in economics, architecture and engineering.

The project envisages a one-year job rotation period in 3 corporate departments or areas throughthe scheme for transversal skills development to learn how to conduct real estate business in anall round perspective. The on the job training project is completed by a classroom training trackdesigned to develop and transfer both technical and managerial skills.

60% of participants in the project found employment in the Company. In 2007 the Campus Projectwill be organised for the second consecutive year.

Another project organised in 2006, in this case by Pirelli Tyre, was “Recruiting day at theVizzola track”. On this occasion 70 undergraduates from the most prestigious universities hadthe opportunity to attend a course on safe driving during the early part of the day; they later par-ticipated in a first screening phase held by means of an innovative team game.

Another initiative organised in the Career Days’ framework was Recruiting Day at the MilanPolytechnic – “Lunch with Pirelli”. This event saw the participation of staff from the Pirelli HRDepartment to explain the corporate framework and the Company’s recruiting process.

A number of Line Managers belonging to three different areas (i.e. managerial, mechanical andelectronic/TLC) also participated in the event. They elaborated on job openings and answered theparticipants’ technical and specific questions on the type of work. Finally, all candidates partici-pated in individual interviews.

T R A I N I N G A N D D E V E L O P M E N TTraining & development tools

Summarised below are the Group’s main training & development tools:

» Skills Catalogue: the Skills Catalogue is geared towards creating a common land-mark to define training activities, in order to meet the need to develop skills and theorganisational behavioural patterns required of Pirelli Group employees.

The Top Management defined reference skills (grouped into 10 categories to enableeasy identification) during the Pirelli Values certification process. To enhance a com-mon language, the Skills Catalogue backs the spreading and implementation ofGroup skills. It enables to perform a training analysis and meets the specific require-

272


RECRUITING DAY 2006 INVIZZOLA

ments related to the role of Pirelli managers.

» Potential Assessment Manual: Assessment Centres, Development Centres andoverall Feedback Questionnaires sustain both moments of awareness enhancementand the monitoring of managerial potential. Such tools are also used in the GroupTalent development framework (in various phases of corporate life) and they alsophotograph various professional family populations.

» Performance Gauge Tool (PM): based on a transparent, shared and objective per-formance evaluation system, it is an important tool both from a performanceimprovement perspective and to back manager-associate relations.

In 2006 the Group focused on relaunching this process through a more slender andflexible online tool.

Early in 2007 all managers will be involved in classroom training sessions.

» Global Grade System: this handbook provides guidelines for using the GlobalGrade System and how it is related to the Standard Positions. Each Standard Positionmay be broken down into: technical-professional skills, competencies/attitudes,background and organisational structure. Finally, it provides support in designatingspecific roles, recruiting, job posting, organisation charts, pay schemes, developmentschemes, and target-setting for the incentive scheme.

Training & Development Projects

Described below are the main Training & Development projects:

» Executive Best Practices (designed for the Tyres Operations sector’s senior man-agement): project goals envisage the creation of dialogue, vision and common com-mitments to facilitate effective organisational changes, construct “teams of leadersand team leaders”, spread managerial culture inside the organisation, provideself–development tools and opportunities, align managements and backing systemsto promote and strengthen the constant development of management in the TyreBusiness’s Operations area.

The programme includes the following 4 modules: Managing People, ManagingRelations, Managing Innovation and Managing the Unexpected. The project’s followup was developed through two individual coaching meetings to define each manag-er’s personal professional development and growth track.

» Intercultural Management in China: 2006 saw the close of the workshop cycledesigned to enhance the skill to recognise differences in “cultural frameworks”resulting from the convergence of European and Chinese culture, besides acquiringmore detailed knowledge and information on the latter’s macroeconomic framework.

» Managerial Development in China: a Development Centre programme wasorganised for a group of fifty managers to define each one’s progress concerningskills and a personal training programme.

» Training online on CSR: an awareness-raising tool on the topic that was spreadthrough the Group’s Intranet system to all employees.

The communication project for all Pirelli Group employees was implemented bydefining posters and leaflets dedicated to the topic of CSR; the distribution of mate-rial to all Group employees will be completed in 2007.

273


8 Pirelli’s classification

system of corporate

positions/roles.

The material comprises part of the classroom training activities that will take placein 2007 for all employees who work by Pirelli’s production facilities based in emerg-ing countries

» Start-up Romania Tyres: training opportunities especially for on the job trainingwere organised for approx. 125 workers during the start-up phase of the new Tyreproduction plant in Romania. These workers were provided with both theoreticaland on the job training in the Group’s production plants based in Italy, Turkey andGermany.

Staff were given a prolonged training period (approx. 3–4 months) depending on therole played. Topics of discussion numbered Group values, its Ethical Code and mul-ticultural differences.

In the framework of training activities provided by Pirelli Real Estate, 2006 saw the com-pletion of the traditional training catalogue. It was designed to develop managerial and profession-al skills with targeted integrated training geared towards meeting the requirements of well definedprofessional families and sectors.

The following projects are worthy of note:

» Company Kitchen – Ingredients for a Team: this outdoor team building projectresorted to the kitchen as a “metaphor of the corporate team”.

The Residence Business Unit’s entire team experienced the ‘innovative trend oflearning by doing at the stove, based on the theory that high quality cuisine requiresthe use of resources, knowledge, organisation and methods, as basically occurs in acorporate team.

It was an opportunity for everyone to exchange ideas and experiences and to engagein some healthy competition: the people involved were divided into three teams thatcompeted in various tests by preparing savoury lunches under the guidance of a pro-fessional chef. The experience encouraged discussion on relational and communica-tional dynamics, in an entertaining manner in the breath-taking setting of the BarillaAcademy in Parma.

» Training for Buyers: project inspired by a well defined organisational need, i.e. togroup the professional family of buyers under a single Department, even if they comefrom different companies and experiences. The project commenced by mapping allbuyers’ skills to define the required training level. The training track, which is organ-ised in 11 days (3 held in 2006 and 8 to be held in 2007) that alternate the develop-ment of technical expertise and managerial skills, is designed to encourage all roundconsiderations on the various skills required of buyers in the current corporateframework.

» Training for Credit Servicing: this training project centres on the corporateframework of Credit Servicing, which in 2006 experienced a merger between PirelliRE Credit Servicing and SIB. The training track is organised in different levels, rang-ing from training on newly adopted software (Fenice system) to course tracks withspecific goals, such as integration, regulatory updates and the development of typi-cal managerial skills for the activity performed.

» Mirror: this track differs from classical training modules in that it involves a prelim-inary phase for participants to evaluate and establish their self-development planafter the Development Centre experience. The project comprises 5 MirrorWorkshops that are preceded by an introductory kick–off and an analysis of training

274


requirements, besides a wrap–up to summarise and evaluate the situation. Everyworkshop centres on a “set” of specific managerial skills, such as, for instance, lead-ership, negotiation, relational skills and self–development. Specific practical trainingsessions designed to create a sense of commitment and continuity in participants arelaunched between one workshop and the next.

» Getting Ready for Management: this is both a celebration and a training sessiontargeted at newly appointed executives in the Real Estate Group. The meeting’s train-ing goal is to inform participants about the latest in the administrative field, provid-ing food for thought in a managerial framework in the light of their new role

» Accelerating Self Enhancement: a 7–day training track targeted at newly appoint-ed executives in the Real Estate Group. The meeting is geared towards developingand enhancing the participant’s cognitive and emotional personal resources toachieve effective leadership that can produce significant changes in his or herprogress.

275


Talent retention inititives and tools*

Talent Retention levers through which the Group operates are organised as follows:

» Career Development Programmes: these tracks are designed to promote thedevelopment process of High Potential Personnel in various phases of their profes-sional life. In association with the best European business schools, these pro-grammes are organised, managed and coordinated at a Group level to provide solidskills and the capacity to make the most of one’s potential. Each step envisages a spe-cific training and development plan.

The following diagram describes the entire process, course placement and the respective pro-grammes:

The Career Development structure will be updated in 2007. This updating will include an increasein the number of Development Centres, including regional centres with courses in the local lan-guage.

The 3 main steps (i.e. UBC, MGC, DME workshops) that envisage one week periods of pure train-ing remain unchanged.

The following is a concise but brief description of the contents of the three mentioned workshops

1) Understanding Business Complexity (UBC) – the workshop is designed to viewbusiness from the right perspective to move in multiple directions – to this end per-sonal experiences are compared with those of colleagues from the other Group busi-nesses corporate departments and different cultural frameworks; to encouragegreater awareness of personal professional skills and values; to assess participants’alignment with both high potential profile skills and Pirelli values; and, to constructpersonal future development; in this regard instead Pirelli Real Estate envisages aDevelopment Centre.

2) Managing Your Growing Complexity (MGC) – develops skills to help face the

276


managerial role’s growing complexity, understand success factors in the decisionmaking framework, provide participants with feedback on motivations, skills andareas open to improvement and provide assistance in defining a well structureddevelopment plan.

3) Developing Managerial Excellence (DME) – designed to understand the linksbetween the various functional frameworks and their impact on the management ofbusiness projects and to develop complex managerial skills (i.e. analysis of difficultcontexts, problem solving, multicultural teams, stress management).

The following tables show attendance at the three workshops held in 2006 and 2005 in terms ofnumber of participants by country of origin:

Further Talent Retention tools in the Training and Development framework, besidesTalent enhancement and development, are Development of Skills by ProfessionalArea, Development of Professional and Managerial Skills, the Fostering ACF Skillsprogramme and the Running the Market Project.

» Development of Skills by Professional Area – this path includes training pro-grammes that are geared towards improving, deep-rooting and spreading expertise ofspecific professional areas (e.g. Administration and Control; Sales and Marketing;Manufacturing and Quality; Personnel; R&D), focusing on the “hard” and “soft” pro-fessional skills required to achieve professional excellence. Talents required for thevarious roles are especially highlighted.

277


CAREER DEVELOPMENT PROGRAMME 2006

UBC10

Italy2

Germany1

Spain1

Turkey2

Brazil2

UK1

Argentina

TOT UBC 2006: 19

MGC12

Italy3

Germany2

Egypt1

Turkey2

Brazil1

UK

TOT MGC 2006: 21

DME13

Italy1

Germany1

Japan1

Greece2

Brazil-

TOT DME 2006: 18

CAREER DEVELOPMENT PROGRAMME 2005

UBC23IT

3 GER

2SP

5BR

4GB

1US

1VENEZ

1FR

1CINA

1MEX

1COM Units

TOT UBC 2005: 43

MGC21IT

5 GER

1 SP

4BR

2GB

3US

1AUSTRALIA

1UNGH

1MIDDLE EAST

-

TOT MGC 2005: 39

DME16IT

1 GB

1RUSSIA

1BR

-

TOT DME 2005: 19

» Development of Professional and Managerial Skills – this path includes train-ing programmes designed to improve, strengthen and spread Pirelli Group profes-sional and managerial skills that are deemed necessary to hold increasingly complexposts (e.g. integration programmes for new recruits, transition programmes fromjunior to senior posts and programmes for recently appointed managers). In this casetoo special focus is reserved for Group Talents. In 2006 a new course called“Coaching & Feedback” dedicated to help managers better develop their associates’management skills through feedback and coaching techniques was added to Pirelli’straining catalogue.

» Fostering ACF Skills – this training programme was developed for the profession-al family Administration, Control and Finance to construct a growth track for futureCFOs, to improve specific skills and to enhance the sense of belonging to the profes-sional family itself by capitalising the most significant best practices both inside andoutside the Company. Designed and managed in collaboration with SDA Bocconi, thetraining track will continue in 2007 with further modules geared to develop manage-rial skills that are closely linked to the roles envisaged in the professional consideredarea.

» Running the Market – a project designed to map commercial skills required in theEuropean area. A training plan focused on filling the gap in skills and on developingrole skills has been defined on the basis of mapping results. The training courseenvisages technical, professional and managerial training modules. In 2007 the samecourses will also be organised in English for personnel belonging to the Europeancommercial units.

Training Activity Figures

The following table reports the number of average training days per person by professional cate-gory. The table also shows variations recorded in 2006, compared to 2005:

2006 (AND VARIATION 2006 VS 2005)Personnel Training Latin(average days per person) Europe U.S.A. America Others TotalExecutives 2.2 0.0 6.9 1.1 2.4Staff (including Cadres) 6.3 0.9 7.2 6.3 4.6Blue-collar 2.4 0.5 5.2 1.5 3.5Total 2006 2.9 0.7 5.5 2.5 3.8total 2005 2.7 0.2 3.4 1.3 2.8Variation 2006 vs 2005 0.2 0.5 2.1 1.2 1

The above reported increase in training days per person organised in Europe in 2006 is the out-come of more catalogued training activities dedicated to the Management and to initiatives imple-mented for specific professional families. We must also consider the impact of training providedin the new site in Romania (Slatina).

The significant increase in figures for Latin America is a result of training provided to blue-collars,especially concerning professional/legal activities (safety etc...).

The increasing training results in the “others” item stems from new training/development activi-ties implemented at Pirelli’s Chinese branch and targeted at enabling blue-collars and staff to cor-rectly carry out their roles.

278


I N T E R N A L C O M M U N I C A T I O N

C O M M U N I C A T I O N C H A N N E L S

Pirelli Corporate Press

In the internal communication framework promoted by Pirelli, the corporate press plays a primaryinformative role, as witnessed by both the high number (currently 28 magazines) and quality ofpublications produced by the Group’s Affiliates and targeted at employees, stakeholders, authori-tative institutions and external opinion makers.

This ‘mixed’ distribution is proof that the Pirelli Group’s corporate press plays an increasinglyextensive role of information and interaction, since it is not solely designed for internal circula-tion, but also for ‘communities’ of associates, suppliers and, in a broad sense, for all those whooperate around the Group and for local communities in whose framework Pirelli operates in thevarious countries.

2006, in particular, witnessed the release of a considerable number of magazines in countries withremarkable market differences. The Italian production plant in Figline Valdarno has created theexquisitely technical bulletin “Il Filo di Arianna” – designed solely for internal circulation, whichwitnesses the high standards of discussions on production and safety issues.

In Spain, HR and Marketing Departments have introduced two new magazines – “Pirelli News” and“Planet Pirelli” – that enhance and integrate communication with employees and external stake-holders in response to an increasingly mature market. In Brazil, the new monthly magazine called‘Giro’ – published in recycled paper consistently with the Group’s environmental policy – hasabsorbed the previous three magazines, thus optimising the use of resources and distribution inthe large South American area.

Lastly, a new publication – “Pirelli Newsletter” – published in two editions (English and Chinese)and targeted at all South–East Asia has been released in Singapore, where a Chinese version of themagazine Pirelli World published in Italy was already distributed. The first issue of “Pirelli TreNewsletter”, whose print run of 20,000 copies has just been distributed in China and will reach andinform the drivers of Asian market dynamics,

The full colour 28 periodical magazines published by the Group both in Italy and worldwide are ahighly relevant and significant asset for Pirelli because they spread information, strengthen cor-porate identity and promote visibility. The table below briefly reports their main details.

279


PIRELLI GROUP

CORPORATE MAGAZINES

COUNTRY TITLE LANGUAGE TARGET FREQUENCY PRINT RUNItaly Fatti e notizie Italian Employees Bimonthly 13,500

Pirelli Flash Italian Employees Monthly 6,600 Pirelli World English 9 Management Quarterly 13,500

Pirelli (worldwide) Il Filo di Arianna 2 Italian Employees Six-monthly 500

Germany Pirelli News German Employees Monthly 2,000 Great Britain Pirelli News English Dealers and Six-monthly 7,000

Consumers Inside Pirelli English Employees Quarterly 1,000Team Pirelli English Consumers Six-monthly 8,000

Portugal Planet Pirelli Portuguese Czech Republic Messaggero Czech External public Four-monthly 20,000 Spain Pirelli In Spain Employees On special 250

(Castilian) occasions Flash quality Catalan Employees Quarterly 800 Flash security Catalan Employees Quarterly 800 Pirelli News Spanish Employees 1,000

(Castilian) Planet Pirelli Spanish Dealers Four-monthly 3,500

(Castilian) Turkey Pirelli Radial Turkish Employees Bimonthly 7,500

and External public United States Pirelli Newsletter 3 English Dealers and Quarterly 7,000of America Consumers Argentina Pirelliando Spanish Employees Bimonthly 1,000

and External public Mejorando Spanish Employees Bimonthly 1,000

and External public mkt 3 Spanish Employees, Six-monthly 5,000

dealers and national press

Brazil Giro 4 Portuguese Employees Monthly 7,200 MotoPneu Portuguese Dealers Quarterly 10,000 MotoPasioN 5 Spanish Dealers Quarterly 6,000

COUNTRY TITLE LANGUAGE TARGET FREQUENCY PRINT RUNBrazil (Columbia,

Argentina, Mexico)

Chile Pirelli E-News Spanish Employees Bimonthly online and Dealers

Mexico Pnewss Spanish Employees and online External public

Venezuela Mundo Pirelli Spanish Employees and Bimonthly online External public

China Pirelli Tyre Newsletter 6 Chinese Dealers, Bimonthly 20,000 Retailers, Consumers, the Press

Singapore Pirelli Tyre Newsletter 7 English ManagementChinese and External public

(Singapore, Malaysia,Indonesia, Thailand,South Korea,The Philippines,Taiwan,Hong Kong) Quarterly 8,000

280


2 Published and

distributed in the

steelcord production

plant in Figline Valdarno.

3 10,000 at the SEMA

Show in Las Vegas.

4 In 2006 it replaced

Pirelli Flash and PQT

Ativo.

5 Distributed since

January 2007.

6 Distributed since

January 2007.

7 In 2006 it replaced

Pirelli World in Chinese.

9 From 2002 to 2006 also

in Chinese.

A rich and diversified publishing scene indeed: a family of magazines linked by goals andcontents. Each magazine has its distinguishing features that mirror the specific traits of thecountry where it is conceived and circulated. The coordination and check of contentconsistency with the Group’s ethical values and communication policies are ensured by theMilan–based Pirelli Corporate Human Resources and Media Relations Departments. ThreeItalian magazines are registered periodicals as they are of public interest,and not at prevalentadvertising content; these magazines are edited by a pool of editors and are directed by aprofessional journalist.

Beyond language, format, periodicity and circulation differences, the content and function of allpublications considered in this Sustainability Report are chiefly informative with low advertisingcontent. They focus on the dual goal of conveying information that is as consistent, complete andcapillary as possible and of encouraging the Pirelli Group, its associates, stakeholders and localcommunities where they operate to exchange and share facts and values.

Knowledge Management Methods

The Pirelli Group has always been committed to spreading knowledge within the corporate frame-work to generate wealth from its very intellectual capital.

Expertise development is valuable for the creation of increasingly efficient and effective process-es that improve quality and reduce times and costs, thus creating value for the client on the onehand and for Pirelli personnel on the other.

Pirelli knowledge management activities can be divided into two macro–areas: online activitiesand offline activities.

Many online activities can be accessed by the corporate intranet system, which is the most wide-ly used knowledge management tool by Pirelli worldwide employees. We can, for instance, men-tion the following tools and activities:

» Learning communities to learn content categorised by functional area

» “Knowledge at work” platforms for information exchange on the state of projectsadvancement

» Electronic notice boards targeted at conveying corporate messages to all employees

» Handbooks to refer to for technical expertise

» Mailing lists for internal communication campaigns and social promotion.

With regard to offline knowledge management, we note the following:

» The Chief Knowledge Officer’s role and activities – who is the reference corporatefigure for technical expertise on product and research

» Road shows – meetings that convey corporate strategies at all organisational levels

» Corporate training and targeted training – large scale learning programmesdesigned to cover an extensive range of both business and managerial contents

» Improvement Teams in industrial areas designed to improve processes

» The use of corporate notice-boards to communicate with factory personnel.Tailor–made courses are also organised for factory employees to compensate for theimpossibility of conducting online training.

281


Knowledge management tools are steadily developing to improve both employee satisfaction andcustomer-oriented performance.

In this perspective 2007 will see the implementation of a development project for the corporateintranet system and of new communication tools targeted at both the internal and external com-munity (suppliers, clients, local communities, etc.).

Group Opinion Survey

2006 saw a wide-ranging communication action of results that emerged from the first worldwideopinion survey launched by Pirelli in November 2005.

Considering a result analysis conducted in a specific mode and differentiated by country, profes-sional family and business, results were published in the corporate intranet systems with the samesegmentation. Intranet communication was enhanced with informative moments and feedbackfirst involving Country Managers and Central Department Directors and, gradually, other levels ineach facility (through specially organised focus groups) to effectively share and interpret theresults that surfaced and to encourage the identification of targeted bottom-up improvementactions.

Such a structured wide-ranging action was geared towards encouraging greater focus on effectiveinternal communications (this need emerged from the survey outcome).

Awareness of the results obtained led to the Group’s commitment to implement both local andGroup improvement actions, in response. In particular, in response to areas defined in 2006 asrequiring improvement, the Performance Management process that will be massively launchedand implemented in 2007 was redefined (it is described exhaustively in the Training &Development section); the Career Development Programme was also revisited by highlighting anddistinguishing assessment moments from training; and, lastly, worldwide communication of theEqual Opportunities Project was commenced. In 2007 the latter will involve the implementationof “positive actions” in the framework of Human Resources Management and work-life balance,based on the principle of optimising differences and equal opportunities.

In the light of the high participation rates in this first worldwide opinion survey (approx. 70%) – asign of people’s involvement and their wish to contribute towards the Pirelli Group’s improvement– in 2007 the Group will conduct a second edition of the opinion survey, this time involving labourcategories as well as management and staff.

I N D U S T R I A L R E L A T I O N S

The Group’s Industrial relations are carried out as a constructive dialogue, fully respecting fair-ness and the respective roles. Guaranteeing and respecting employees’ freedom to engage in unionactivities has always been one of the company’s key points.

Relations and negotiations with Trade Union are managed locally, in accordance with the laws,national and/or company level collective agreements and customs and practices in force in eachcountry. This is supported by the guidance and supervision of central Company Functions, whichintervene to ensure the appropriate aspects of activity coordination and to guarantee the afore-mentioned principles.

In 2006 Industrial Relations activity reached important goals: the renewal of collective agreementsin many of the Group’s production plants without unrest, as occurred in Italy, United Kingdom,Germany, Turkey, Romania and Brazil. This confirms the relevant effects of the aforementionedpolicies on the outcome of negotiations.

282


Two important projects to establish two new modern production plants designed to replace thecurrent sites in Settimo Torinese (Lombardy, Italy) and Manresa (Spain) have commenced, involv-ing Trade Unions and the local Public Administration.

T H E E U R O P E A N W O R K S C O U N C I L

Set up in 1998, the Pirelli European Works Council (EWC) was designed to encourage dialoguebetween the Company and its employees, namely, the information and consultation throughDelegates on the overall progress of the Group’s European companies and and on its generaldirections.

EWC Delegates are provided with the IT tools required to perform their duties and a connectionto the corporate Intranet system, for the real time communication of official Company’s pressreleases.

The Council meets in ordinary session once a year, following the presentation of the financialstatement, to learn about economic trends, financial-economic forecasts, investments carried outand planned, progress in research, etc.

Extraordinary meetings are also envisaged whenever information and consultation are required inthe light of transnational events that concern important corporate changes, new openings, therestructuring or closure of sites and relevant widespread work organisation innovations, alwaysin Europe.

During the 2006 annual meeting, the Equal Opportunities Project, the report of the relevant resultsachieved by Pirelli Real Estate and options for its future expansion abroad were introduced anddiscussed, besides the usual topics.

In light of the European Union’s enlargement, as from 2007 participation in the Pirelli EWC willalso be extended to Romania.

C O M P L I A N C E W I T H L E G A L A N D C O N T R A C T U A L R E Q U I R E M E N T S

O N O V E R T I M E A N D T I M E - O F F

The policy of complying with all legal and/or contractual prescriptions concerning overtime workand the right to periodical days of rest applies to the entire Pirelli Group. These topics are oftenthe focus of understandings both with trade unions and individual workers, respecting the manydifferent regulatory contexts.

Every worker’s right to use his or her total number of holidays suffers no restrictions. The holidayperiod is generally agreed between the worker and the Company.

L A B O U R A N D S O C I A L S E C U R I T Y L A W S U I T S

Broadly speaking, conflicts recorded level is low, hence the low entity of labour and social secu-rity lawsuits.

In the entire Group, except for Brazil, 56 new lawsuits were filed in 2006.

In Brazil the incidence of labour-related lawsuits is traditionally high, numbering over 90% of law-suits brought against the whole Group, to date.

This phenomenon is also present in other multinationals operating in this country, where,general-ly labour-related lawsuits are brought when an employment contract is terminated and the suitsusually concern the interpretation of regulatory, legal and contractual issies that has long beencontroversial.

283


U N I O N I S A T I O N I N D E X A N D I N D U S T R I A L A C T I O N

The Group’s unionisation index cannot be precisely calculated, since this information cannot beprovided by all countries. We can however estimate that about half the Group’s employees aretrade union members.

The percentage of employees covered by collective agreement in 2006 remains unchanged com-pared to the previous year’s and is around 85%. This percentage is the result of the various nation-al frameworks’ historical and cultural differences. In some countries, e.g. Italy, all employees’employment contract are regulated by collective agreement, while local laws are applied in othercountries, like China.

Individual contracts are held by approximately 10% of the employee population, e.g. executivesworldwide, except for Italy, Managers in the UK, “Non Tarifs” in Germany, “Excluidos” in Spain,“Senior” and “Esecutivi” in Brazil.

The overall conflict rate recorded in 2006 was very low.

Industrial actions during the year were only recorded in Italy and Brazil.

Concerning the Brazilian production plant Santo André, the two-hour strike demanded a bettercanteen service.

Disputes in Italian production plants, instead, concerned managerial aspects. They were all speed-ily and positively solved.

O C C U P A T I O N A L P E N S I O N P L A N S A N D H E A L T H C A R E S C H E M E S

Turning to pensions and healthcare plans, the situation has undergone no relevant changes in2006. Most affiliates still provide supplementary pension schemes for their employees.

The Group’s policy envisages removing defined-benefit funds to the advantage of defined-contri-bution funds. Almost all supplementary pension funds in the Group are indeed defined-contribu-tion.

Defined-benefit funds can only be found in the UK (they concern employees who were hired priorto an established date, while those hired after that date participate in a defined contribution fund),in the USA (some years ago these funds were closed to active employees to the advantage ofdefined-contribution funds; since then they only cover retired personnel and they are not influ-enced by wage increases) and in Germany (the plan was closed to new hires in 1982).

Pension schemes are generally completed by insurance policies against death and permanent dis-ability.

In Italy the subject is developing with the introduction of supplementary pension funds in recentyears and with recent provisions on the allocation of the retirement allowance.

Even regarding supplementary healthcare schemes, 2006 is basically the same as 2005, since noessential events have influenced them.

Healthcare schemes envisaged by the Company offer levels and forms of coverage that differ fromcountry to country, in compliance with local needs. Most of these schemes are managed byInsurance Companies and specially created Funds. The Company participates by paying a fixedrate, as occurs in Italy, or an insurance premium, as occurs in Brazil and in the USA.

284


O C C U P A T I O N A L H E A L T & S A F E T Y A N D I N D U S T R I A L H Y G I E N E

Health, Safety and Hygiene Management complies with the Pirelli Group Policy for Health, Safety,Environment and Social Responsibility, whose contents can be found in the introductory section.

The Policy’s complete text, which was conveyed to all Group employees in their respective lan-guages, can also be accessed from the company website, www.pirelli.com, in the “Sustainability”area.

To ensure greater precision, the various topics discussed below will be divided under “PirelliTyre”, “Pirelli Real Estate” and “The Group’s Other Sectors/Companies”.

S A F E T Y M A N A G E M E N T

Pirelli Tyre S.p.A.

A Safety Management System organised and certified to meet OHSAS 18001 standards has longbeen in operation in the Tyre Sector (which also comprises steel cord production plants).

At the close of 2006, the Operational Units certified to this standard numbered 19 (on a total of 24production plants); 5 plants are now implementing their Safety Management System.

The Safety Management System implemented in the Group’s production units has been developedon the basis of centrally drafted common procedures and guidelines. This has enabled the use ofa “common language” inside the Group, in terms of key elements for Safety Management in work-places and a common one-track operating mode.

Pirelli Real Estate S.p.A.

In the light of Pirelli Real Estate S.p.A.’s kind of performance, which is basically related to “serv-ices”, a formal certification of the Safety Management System based on the OHSAS 18001 stan-dards was not deemed necessary.

The corporate organisation is structured as follows:

A delegating process (delegating chain) for Safety Management, including a “spending power”,envisaging a Control System for delegates has been implemented.

“Peripheral Management Committees” have been established – since 2006 Safety Department rep-resentatives have also participated in Peripheral Committees for Operational Areas (only PirelliRE Facility’s operating areas spread throughout the national territory: Milan, Ivrea, Genoa, Rome,Naples and the Italian islands) to sensitise all operational area personnel on topics concerninghealth, safety, accident prevention and work hygiene.

Moreover, from 2006 the Safety Manager has organised meetings with groups of Pirelli RE Facilityoperatives both to involve them and to hear their opinions on work safety issues.

These meetings were also extended to some Territorial Trade Union Organisations to describe the“Safety Management Models adopted by Pirelli RE” and to sensitise the workforce on the topic ofprevention and safety, even with the external trade union’s contribution.

Since 2005 Pirelli Real Estate SpA’s Central Safety Department has participated in PeriodicalCommittees for the General Management of Pirelli RE Property and of Pirelli RE Facility with theprecise purpose of constantly updating Department Managers on the topic of Accidents,

285


Prevention, Protection and on actions designed to gather information and to steadily manage andimprove company’s and managed real estate assets safety levels & standards.

A system was also introduced for emergency and First Aid services mapping and management.

Since March 2005 Prevention and Protection Department Managers have been present in all PirelliRE Facility’s territorial operations areas (i.e. Milan, Ivrea, Genoa, Rome, Pozzuoli and Palermo),while a dedicated department operates centrally for the other companies.

Besides receiving the legally envisaged training, appointed personnel are constantly updatedabout new legal provisions and they are provided specific technical updates through the documen-tation and implementation of sustaining actions.

The Prevention and Protection Service continues its assistance, information and “proactive con-trol” service for all company operational facilities.

Pirelli Real Estate devotes special attention to safety management in building yards in compliancewith Legislative Decree no. 494 dated 14 August 1996, which implemented the Directive 92/57/EECconcerning the minimum safety and health measures to be ensured in either temporary or mobilebuilding yards (i.e. large building yards for construction works/extraordinary maintenance).

For such activity, a safety control and monitoring system has been established for individual build-ing yards, in order to guarantee the specific law’s application level and relevant requirements.

Though the following is not directly related to health and safety issues, to ensure completenesswe wish to mention other actions implemented in the aforementioned large building yards:

» Definition of a periodical monitoring system to check that all contractors/subcon-tractors have regularly paid their tax contributions (INPS, INAIL, Cassa Edile)

» Creation of a special team to combat concealed labour and tax evasion (via surpriseinspections in building yards: a project enforced from January 2007 onwards)

» Periodic meetings with control bodies (LHA, only in Milan) to compare notes onexperiences, to discuss new regulations and to fight concealed labour / tax evasion

Other Group Sectors / Companies

As already implemented by the Group’s operational units, Pirelli Broadband Solution, PirelliAmbiente, Pirelli Labs and Corporate also encourage the development of a Safety ManagementSystem based on the Group Policy for Safety, Environment and Social Responsibility.

As already specified for Pirelli Real Estate and, in the light of the characteristics of the said facil-ities and the business performed therein, a formal certification of the Health and Safety Systemwas not deemed necessary in the companies mentioned. It was, instead, deemed appropriate toencourage the local development of management systems that could better adapt to each facility’sfeatures.

A delegating system for Safety with Expenditure Value has been implemented at organisationallevel. There are also local organizational structures designed to support corporate safety manage-ment.

At corporate level, the Health, Safety and Environment Department directs and controls safety,work hygiene and environmental protection throughout the Group.

In particular, corporate structures have drafted the appropriate guidelines and procedures thathave been locally adopted to define Management Systems.

286


H E A L T H & S A F E T Y P E R F O R M A N C E G A U G I N G

Pirelli Tyre S.p.A.

Concerning safety and focusing on injuries data recorded in production plants, the 2005 per-formance has been basically maintained.

Including all injuries that have occurred in tyre factories and based on the sectorperimeter considered in 2005 , the Frequency Index (FI) was exactly the same as in2005, while the Gravity Index (GI = 0.45 ) recorded a 6.6% per cent improvement, com-pared to 2005.

Considering the total number of production plants and also data on the recently opened produc-tion plant in China, which did not exist during the 2005 survey, performance indexes improve fur-ther by reaching FI = 2.92 and GI = 0.43, due to the low injury rate recorded in the Chinese pro-duction plant.

To better understand this data, we remind that the GI was calculated by considering as “lost” allcalendar days between the injured person’s interruption of work and his/her return to the factory,without counting the day of the accident*. Holidays and weekly rest days that occurred in the saidperiod have been included(10).

The calculation of the aforementioned indexes did not include the so called “in itinere” injuries,of wich we specify below.

See the graph below.

Remarking on the above data, we must take into account that the 2005 increase in indexes wasbasically due to the extension to all secotor’s production plants of the European ”definitions”adopted to calculate both injuries and lost working days, which generated a concurrent impacton indexes.

287


FI = Frequency Index = Total number of injuries with work interruption . 100.000

GI = Gravity Index = Total days lost due to injuries . 1.000

Total actually worked hours

Total actually worked hours

10

FI-GI Tyre Factories

Factories Factories

Referring now to employees’ ”Health” issue, the 2006 Frequency Index of new occupational dis-ease cases was 0.24, marking a net improvement compared to previous years. This can be clear-ly noticed in the trend of the below graph.

Even though there is a net improvement recorded, continuous improvement of health, hygieneand work conditions remains our goal .

Shifting focus to injuries occurred in Tyre Sector’s non production units, the following valueswere recorded in 2006:

FI = 1.61

GI = 0.33

Values given only considered injuries that caused the worker to interrupt work for more than 3days (without counting the day of the injury). Data was, in fact, collected from legally requiredrecordings, which, in most cases, only consider accidents that cause absences exceeding 3 days.

2007 will witness the extension of actions designed to reduce the number of injuries in non pro-duction areas, exactly as specified above for production areas.


Considering injuries that required interruption of work for more than 3 days, 2006 recorded thefollowing index values: FI = 0.53 and GI = 0.17.

288


Occupational diseases in Tyre Factoriesper 100,000 worked hours

FI-GI PIRELLI RE

The increase in 2006 number of injuries compared to 2005 (due almost entirely to Pirelli REFacility), was caused both by road accidents, which cannot be classified as ”in itinere” injuries,and by the Company’s effective industrial injury rate.

It should also be noted that, compared to the Sector Index (last INAIL available data), the RealEstate Group’s accident rate was approximately half the sector’s average rate.

To fight injuries’increase in 2006 the following initiatives were implemented:

» Raising of both Facility operations areas Managers and specially appointed person-nel awarness (prevention campaign for operational personnel);

» Publication of a “Safe Driving” Handbook to prevent road accidents;

» Half-year injury analysis: classification and analysis of each injury and relevant cir-cumstances;

» Prevention and Protection Department’s on site visit, each time an injury hasoccurred

No work-related illnesses were recorded in 2006.


Pirelli Broadband Solution, Pirelli Ambiente, Pirelli Labs and Pirelli Corporate’s injury rate alsohighlight that 2006 basically maintained the 2005 performance, with FI = 0.05 and GI = 0.001.

In itinere injuries:

Information on in itinere injuries (i.e. occurred during work transfers or while travelling to reachthe workplace) was collected and elaborated in 2006.

The total number of in itinere injuries recorded by the whole Group was 128 (i.e. 4.5 accidentsevery one thousand workers).

Fatal accidents

In 2006 Pirelli Group employees met with no fatal accidents.

Yet, two employees employed by an external company died. The accident occurred in Brazil – inPirelli Tyre’s Feira de Santana production plant – during a work on electrical energy distributioncables.

S H A R I N G O F E X P E R I E N C E S B E T W E E N P R O D U C T I O N P L A N T S

All information on injuries is collected in a tailor-made IT systems (injury analysis, correctivemeasures adopted, etc.). In case of significant accident dynamics, all production plants areinformed and requested to: 1) internally check the existence of conditions being similar to theones that have caused the specific injury and, 2) define corrective actions, if the case.

Through the IT systems the solutions adopted by the various production plants are recorded andsolutions deemed as the best ones are shared.

Staying with this knowledge sharing perspective, along with the above information we also wish

289


to mention Pirelli Real Estate’s Web project. To better study and develop a sahred safety-orientedculture and to allow availability/access to useful information for safety issues practical manage-ment, in 2006 the Company developed a dedicated website. At the close of the year the websitecontained over 60 work tools that could be shared, many of which are highly innovative and tar-geted, among the others, also at operative employees, specially appointed personnel and projectmanagers.

A W A R E N E S S - R A I S I N G A N D T R A I N I N G A C T I V I T I E S

Pirelli Tyre S.p.A.

As in previous years, 2006 too witnessed active actions in terms of sensitisation and training onhealth and safety issues with initiatives targeted at all responsibility levels and designed to encour-age naturally safer conduct.

The Safety Training Programme for new hires and for those who, in various capacities (agencies,interns etc.), have commenced work with Pirelli was continued in 2006.

Training for personnel with operational assignments was provided through specific sessions heldboth in the classroom and, especially, on the workplace. Educational tools also numbered opera-tional instructions that describe the typical duties of the various roles. Experience gained follow-ing risk analysis reviews and those resulting from past injuries were also shared.

All production plants trained a number of workers to handle emergencies.

Considering the different nature and potential gravity of injuries that can occur in the Group’s pro-duction plants, every unit targeted and adjusted both the number of people trained and the typeof training to suit its specific requirements.


The periodic information programme targeted at all Safety Delegates and at specially appointedpersonnel for new regulations concerning safety, prevention, protection, environment and man-agement of property assets was continued in 2006.

As in previous years, Health & Safety Training involved both new hires and personnel in servicein both general and specific issues (e.g. electrical risks, building site safety, etc.).

“User request” training forms were also designed and customised in 2006. They led to courses onthe “Facility Manager’s Role and Responsibility for Prevention and Safety”, on “Safety OperationsPlans for Facility Workers” (with a special section on “extractable” risks for individual exposedworkers) and, on “Work at Heights” (training for the use of Individual Protection Devices).


Also in Pirelli Broadband Solutions, Pirelli Ambiente, Pirelli Labs and Corporate, Safety is a cen-tral element of training programmes for employees.

In 2006 training organised in the abovementioned companies also concerned, among the others,safe working practices in laboratories and during experimentation.

290


H E A L T H & S A F E T Y E X P E N D I T U R E A N D I N V E S T M E N T S

In 2006 the highest expenditure and investments were recorded by Pirelli Tyre and Pirelli RealEstate, as described in the following sections.

Pirelli Tyre S.p.A.

In 2006 safety investments and expenditure reached a total of approx. 6,500,000 euro.

Investments focused on improving machinery and plants and, in a broad sense, on the overallwork environment (i.e. improvement of microclimate and lighting conditions, layout changes toimprove operating ergonomics, interventions to protect infrastructures healthiness, etc.).

Expenses sustained for safety reasons, instead, basically focused on work environment control-ling activities (i.e. sampling and analysis, consultations, etc.), purchasing individual protectiondevices (e.g. injury prevention shoes, gloves, safety eye-glasses, etc.) and collective protectiondevices (e.g. better protection of machinery, suction systems and, in general, workplace environ-ment).


Though expenses were faced for Safety Management, such expenses/investments were not sepa-rately recorded; hence it is not possible to report on a precise consolidated data.

Specific projects aimed at improving this reporting aspect will be implemented in 2007.

H E A L T H C A R E A S S I S T A N C E D U R I N G W O R K I N G H O U R S

For decades Pirelli has implemented infirmaries operating at its production plants, with nursesand doctors available to provide employees with medical care during working hours.

These facilities provide first aid care, consultancy on non work-related health problems and super-vision for workers exposed to specific risks.

Healthcare promotion campaigns developed in line with local programmes also make use of thesefacilities.

G R O U P F L U P R E V E N T I O N C A M P A I G N

Again in 2006 Pirelli gave its workers the free of charge opportunity of being inoculated with theseasonal anti-flu vaccine.

This initiative takes into account the geographical location of Pirelli facilities; hence there is aneed to provide vaccinations in different periods of the year, depending on the country, in orderto follow the periods of the flu’s seasonal spreading (workers in the northern hemisphere were thefirst to be vaccinated in autumn 2005).

In 2006 the anti-flu campaign was given new impetus through widespread information tools tar-geted at all organisational levels (it targeted workers in the southern hemisphere in spring andthose in the northern hemisphere in autumn).

The number of employees who joined the initiative was approx. 8,000, as at 31/12/2006.

In view of the initiative’s success, this prevention opportunity will be offered again to all person-nel in 2007.

291


N O - S M O K I N G C O M P A N Y

In June 2003 a letter sent by the Top Management to the Group’s Chief Executive Officersannounced the corporate decision to become a “No Smoking Company”, to safeguard both smok-ers’ and non smokers’ health. This decision was consistent with Pirelli’s long-standing policy ofprotecting the health of its employees in every country where the Group operates.

Specific training/information initiatives on damage caused by cigarette smoke were also imple-mented by distributing handouts, by organising conferences on nicotine addiction and by publish-ing questionnaires on smoking on the Company’s Intranet System.

Three and a half years later the smoking ban is applied in most of the Group’s sites, involving 97.6%of employees.

In most cases (78%) areas have been specially fitted out for smokers, while other facilities havetotally prohibited smoking in all areas inside buildings.

In 2006 the Pirelli Group detected and fined 40 internal violations of the smoking ban.

C O M P A N Y I N I T I A T I V E S F O R T H E I N T E R N A L C O M M U N I T Y

Initiatives implemented by the company for its internal community differ from country tocountry, to meet the typical needs of the various social contexts in which the affiliates operate.

Listed below are the most recurrent initiatives implemented in affiliates:

» Funded holidays for employees’ children

» Scholarships and financial aid for employees’ children training

» Corporate clubs for social and sports meetings

» Disease prevention activities through scheduled specialist visits, awareness-raisingand vaccination campaigns

» Agreements with shops and medical practices to the advantage of employees

Starting this year Pirelli has decided to introduce a specific focus paragraph in its SustainabilityReport – in the sections dedicated to both internal and external community initiatives - , aimed atdescribing its activities in a specific geographical area where the Group operates.

For 2006 Latin America was chosen. In this area the various Group Affiliates perform many target-ed actions for the internal community, as well as activities aimed at involving and sustaining localcommunities.

F O C U S O N L A T I N A M E R I C A

Pirelli’s activities in Brazil are many and varied, also considering the Group’s wide presence in thecountry. “Young Apprentice” is a national two-year programme for apprentices in industrialcompanies; it is financed by these companies. Participation in “Young Apprentice” is generallyrecognised both by Pirelli and by the market; hence it offers youth an important opportunity forprofessional development.

All Pirelli production frameworks in Brazil are involved in the programme. In Pirelli’s case it is pri-marily targeted at employees’ relations (i.e. brothers, children and cousins) aged at least 14 years.

292


During the training period, apprentices are registered as Pirelli employees, they enjoy all the rele-vant rights and guarantees (i.e. insurance, healthcare, etc.) and they are paid wages for the envis-aged hours per month.

“Where does Dad Work” is another initiative that is proposed every Sunday in all Pirelli’sBrazilian production sites. Booking is compulsory. Designed for employees’ close family, it espe-cially focuses on the youngest family members. Participants are initially welcomed to the produc-tion plant with breakfast. Some safety information and a corporate introductory video are fol-lowed by a tour round the production divisions and outside the production plant. The visit comesto a close with a demonstration of the fire-fighting unit and lunch in the Company’s canteen. Allparticipants are finally given a small gift to take home. Pirelli’s “Children’s Day Party” inCampinas, Sumaré and, especially, in Gravatai, are also targeted at employees’ family members.They have recorded over 3,500 participants, numbering approx. 1,500 children. Around fiftyemployees will volunteer to organise games, competitions, shows, demonstrations, a visit to thefire-fighting unit and, naturally, a snack for the kids. Satisfaction levels, which are regularly gaugedat the end of the event, exceed 98% of participants.

In Venezuela too Pirelli organises a day for employees’families to visit production plants (“DóndeTrabaja Papá”). In 2006 the same Affiliate also organised the “Concurso de Debujo Infantil”for kids - a drawing competition centring on the topic of Pirelli in Venezuela. In 2007 the Companymeans to select the best drawings done by kids for a special calendar targeted at all Pirelli employ-ees in Venezuela.

Still in Venezuela Pirelli organises “Plan Vacacional” for employees’ children aged between 6and 12 years. In August and September approx. 160 children spent a three-day holiday packed withgames and entertainment. As with all shared experiences, the holiday also had a high educationalprofile.

“Health Week” - concurrently held on Sundays in all production plants, this is an exceptionallyrelevant social responsibility initiative designed for Pirelli’s Brazilian employees and extended totheir family members. This dual phase programme initially involves tests and medical examina-tions, whose results enable the creation of homogeneous groups of people concerning health risksand diseases, to later adopt effective actions to ensure prevention and care. An equally importantgoal is to spread a strong prevention-oriented mentality through precise information, advice andpractical suggestions on diet habits, sources of risks, etc.

In Argentina, Pirelli supports the studies of employees’ children by providing them with books andeducational material. The most deserving students are also given a study grant. Pupils and stu-dents who receive Pirelli’s study grants number over 700.

293


CHILDREN’S DAY PARTY

IN BRAZIL

I N V O L V E M E N T O F T H E I N T E R N A L C O M M U N I T Y F O R T H E E X T E R N A L

C O M M U N I T Y

F A I O N L I N E

In September/October 2006 a group of 60 Shared Service Centre employees participated in an out-door training project organised in collaboration with MAP Responsibility and the Fondo perl’Ambiente Italiano (FAI) that has been created to safeguard and preserve the Italian culturalgoods and heritage. The project involved participants in creating innovative tools to optimiseinformation on certain sites belonging to the FAI heritage.

Participants performed field work to update photographic, historical and artistic documentationof six important artistic sites in Italy in order to update FAI Web pages on these sites.Accompanied by specialists in an enthusiastic interpretation of each monument’s art and architec-ture and, assisted by the consultation of bibliographical material placed at their disposal by theFAI, participants focused on reconstructing the cultural and artistic history of each of theseplaces.

The initiative was a remarkable tool to develop and optimise participants’ skills with special ref-erence to team building, team work and results-orientation. The same participants were also giventhe opportunity to place their qualified skills at the FAI’s disposal; hence, the proposal of new Webpages with more items, texts and images. These pages will contain new photographs with manyenlarged details and many pictures relating the “before and after” renovation works, the history ofthe architectural and pictorial works, cultural events, services offered and all information requiredto reach the site.

C H I L D R E N I N C R I S I S I T A L Y

“Children in Crisis Italy” is a lay and independent non profit NGO organisation designed toimprove the lifestyle of children who are the victims of conflicts, poverty and illness. Consideringthe association’s many activities, Pirelli Broadband Solution and Pirelli Labs – that are deeply con-vinced of the importance of spreading a solidarity–oriented culture and ethical behaviour – havedecided to fully finance the reconstruction of the middle school in Bushushu, in the DemocraticRepublic of Congo. It was destroyed by an earthquake. Along with the school building, the projectalso envisages the construction of a cereal–grinding mill to enable the local community to start upa small business to face the new school’s operating costs. But, besides the direct commitment,Pirelli also deemed it important to spread this sensitivity among its employees, suppliers andclients by informing them and inviting them to contribute with their own donations. The involve-ment of the entire corporate community, on the one hand, and of the business community in whichPirelli operates, on the other, is this project’s most interesting detail. It shows the Group’s author-ity and credibility with its interlocutors.

M Y T I M E F O R I N D O N E S I A – R E C O N S T R U C T I O N W O R K C O M P L E T E D

After the devastating tsunamis that struck South and South-East Asia at the close of 2004, Pirellidecided to contribute towards the reconstruction of damaged zones with the project “My Timefor Indonesia”.

The project’s financial goal was to collect – 500,000 to construct two schools in the Indonesianregions of Aceh, one of the most damaged sites.

Specifically, the schools are two upper secondary technical institutes – one is in the capital Banda

294


Aceh and hosts approx. 1,400 students and, one is in the Aceh Besar province, numbering approx.400 students.

The decision to allocate funds was made in agreement with the Indonesian authorities with whomPirelli signed an agreement on 28 April 2005, considering the essential social role played byschools and convinced that, besides training new generations, the facilities can also be a landmarkfor the entire population in the reconstruction process that followed the calamity.

The amount required to implement the project was collected through the voluntary offers ofGroup employees – payment for the number of hours they decided to donate was withheld by theCompany – and a contribution from the Company.

Employees offered a total of 9,900 hours of work - equivalent to – 166,713 – while the Companydonated – 333,287 to reach the sum of – 500,000. A further contribution was donated in 2006.

A Guarantee Committee for Italy (comprising Pirelli’s Management, the Trade Union and a repre-sentative of Price Waterhouse Coopers) and a Guarantee Committee for Indonesia (comprisingPirelli’s management, the Indonesian Minister for National Education and a representative ofDeloitte) were formed in the project’s framework to ensure transparent fund collecting opera-tions, to ensure the use of funds in the envisaged modes and times, to approve projects proposedby the local work group and to authorise the transfer of funds to third parties for project imple-mentation.

Construction work on the two schools was completed by the close of 2006 and early2007. Both institutes, whose official inauguration is scheduled for the first half of the year, arealready operating.

Updates on the progress of reconstruction works are constantly published in a special section ofthe corporate Intranet system; they can be accessed by all employees who are interested in the ini-tiative.

4 . 2 . E X T E R N A L C O M M U N I T Y

C O R P O R A T E I N I T I A T I V E S F O R T H E E X T E R N A L C O M M U N I T Y

Group companies encourage and, where necessary, provide support for social,cultural and edu-cational initiatives geared towards promoting personal development and improving standardsof living (Article 5 of the Ethical Code - Community).

The awareness of its role in promoting the civil and cultural progress of communities in whichGroup companies operate has always been a focal point in Pirelli’s entrepreneurial culture.

Hence, the Pirelli Group organises and backs social, cultural and educational initiatives by collab-orating with both public and private institutions, local administrations, associations and institu-tions in all countries where it operates.

This commitment is both consistent with the principles expressed in the Code of Ethics and it isan important part of Pirelli’s positioning strategy, which aims at defending and improving theCompany’s role as one of the most integrated and active international companies in the variouslocal communities where it operates.

295


RECONSTRUCTION WORK IN

BANDA ACEH THANKS TO

MY TIME FOR INDONESIA

From a promotional perspective and considering socially oriented actions, the Pirelli Group isinvolved in social, welfare, healthcare, cultural, educational and sports initiatives. All activities arecarried out in association with authoritative partners, the choice of whom is based on criteriadesigned to guarantee their high quality profile.

Concisely described below are some of the most significant initiatives either promoted or support-ed by Group companies.

A Focus on Initiatives in favour of Latin America external community will also follow.

S O C I A L , W E L F A R E & H E A L T H

“Dialogue in the Dark” is an exhibition that was organised in association with the MilanInstitute for the Blind to enable anyone to experience the world of the blind by building confi-dence with their problems and, especially, with the extraordinary skills developed by their “dis-abled” status. Pirelli has decided to confirm its support for 2006 too, both for the important resultsachieved by supporting this activity organised by the institute and, for the excellent response metby the exhibition in 2005.

Concerning commitment in the healthcare sector, we must mention Pirelli’s membership in“Global Business Coalition on AIDS”, a private American body that combines the efforts ofmany companies throughout the world against the plague of the 21st century.

Of the various Italian non profit organisations partnered by Pirelli, a primary role is doubtlessplayed by Emergency. A neutral, non political association with independent humanitarian pur-poses, it is designed to assist the civil victims of war the world over. It is internationally famous.

Pirelli RE’s “Piccolo Fratello” project plans on opening a new home for street children (MduguNdogo, “small brother”) in Kibera (Kenya) to enable deep permanent contact with street children’sliving frameworks and to interact with children who still live on the streets.

The house is, hence, designed to physically remove children from the streets by giving themthe opportunity to attend school and to reside in an environment that protects them, in con-tact with skilled youth workers who love them. It will also be a place where young education-ists who have already attended theoretical courses can experience full immersion in the real lifeof street children.

The project envisages two phases:

» Short term (6 months) as Reception Centre (refuge for the night and meal distribu-tion during the day) and residence for two expert educationists;

» Middle term (within a year) – the house will permanently host 30 – 40 former streetchildren who will regularly attend state–run schools in the neighbourhood. It willalso host 4 – 6 young educationists during their training period.

A –Training Centre for Young Educationists– has also been built in close collaboration with thehouse to back people who are motivated to dedicate themselves to this work in order to give themhigh quality professional skills.

Hence, the intention – by working together with institutions like the Università Cattolica’s Milan’sCentre for Research and Studies on Social Difficulty and Maladjustment, directed by Prof.Giuseppe Vico – is to start a training centre for Educationists specialized on “street children edu-cation” in Nairobi. The programme initially envisages a three-year theoretical and practical coursewith a final diploma. The Centre may later organise a Degree Course and a Master’s Degree.

296


THE “DIALOGUE IN THE DARK”EXHIBITION

Pirelli also pursues its mission of supporting the local Milanese youth by supporting associationssuch as “Fondazione Boccafogli” - dedicated to winning over street youth by encouraging theirartistic and expressive potential and “Fondazione Benedetta d’Intino” which treats autismand perception disorders in childhood.

T H E A T R E A N D V I S U A L A R T S

The Pirelli Group actively supports the valorization of artistic heritage, intelligence, energy andlocal resources of all the countries where it operates. It promotes a model of active collaborationto integrate partners’ skills with company’s skills in the fields of technology, organisation and com-munication.

In this regard, Pirelli has always been involved in backing artistic, cultural and training initiatives.Historical operations like the construction of the Etruscan wing at the Louvre, Paris, or renova-tion works in the Victoria and Albert Museum’s Italian Gardens, London, date back to the 1980s.

Even prior to these events, the Group has long distinguished itself as the Milanese area’s culturalengine by developing the Pirelli Cultural Centre. The Pirelli magazine has been one of the mostexciting examples of international “enterprise culture” for over twenty years.

It is precisely the prestige acquired on the Italian cultural scene that has associated Pirelli – sinceits formation – with Fondazione Teatro alla Scala. In the early 20th century the Company wasalso one of the founding members of the theatre’s museum, which has organised highly success-ful initiatives over the years, including Strehler’s exhibition “The chamber of witchcraft” on diora-mas in small 18th century theatres and “The Poet’s Scene”, which Ronconi dedicated to GabrieleD’Annunzio’s works.

Again in the musical filed, we must also mention the Group’s organisation of the “Concerts forPeace”, which have been held since 1998. This series of musical events, wished by MaestroRiccardo Muti as part of the Ravenna Festival, were held in places that symbolise music’s missionto restore peace: Beirut, Jerusalem, Sarajevo, Erevan, Istanbul and New York, one year afterSeptember 11. And again, over the past two years Pirelli has sponsored “Per non dimenticare”(Lest we forget) – a concert organised by Fondazione 8 Ottobre at the Scala Theatre every year inmemory of the victims of the 2001 air accident at Linate airport.

During the two–year period when Piermarini’s theatre was closed for renovation works, theTeatro degli Arcimboldi – which Pirelli RE built in record time in the framework of its projectfor the reconversion of Milan’s industrial area Bicocca – became the base for the Scala Theatre.This theatre is today the property of the Milan Municipality, which has appointed the Arcimboldias the second Milanese musical theatre that is open to all expressions of music and modernshows.

Always concerning theatres, Pirelli is the historical partner of Fondazione Pierlombardo. Italso backs activities organised by Teatro Franco Parenti – one of the most active theatres that isdeeply rooted in the Milanese cultural fabric. This highly relevant role played by the Group hasbeen acknowledged by naming the exhibition area the theatre dedicates to the artistic expressionsof youth “Pirelli Hall”.

In view of an intervention on the territory, one of the most significant experiences carried out inItaly is doubtless the Hangar Bicocca. With a surface area of 15,000 m–, it was the Ansaldo fac-tory’s former production site, which Pirelli RE decided to convert into a space for ContemporaryArt. Temporary exhibitions are the core of its activity, which is strongly oriented towards researchand experimentation. Every space becomes an inspiration for the creations/interpretations ofartists and curators; hence, the facility’s key to its success is its skill in attracting and generatingartistic and cultural creativity.

297


At the same time Hangar Bicocca is also a place at the disposal of the public, a privileged site thatwitnesses the convergence of art and visitors – a permanent centre for initiatives geared towardsunderstanding visual culture and towards active participation in the role of art in contemporaryculture.

Events are, hence, scheduled to ensure dialogue between the protagonists of contemporary cul-ture and various audience types. International artists and curators play a central role and so dothe protagonists of various cultural frameworks (i.e. music, drama and cinema) who are called tocontribute towards research on contemporary visual culture.

The initiative’s success, the great interest of both the public and of international contemporary artoperators and, the very high response of schools (1,500 schools in northern Italy joined the edu-cational programme launched by Hangar Bicocca in September) have convinced Pirelli RE tomake the operation even more significant and noteworthy by forming an independent structurethat is professionally related with interlocutors in the world of art, thus depersonalising theCompany’s role.

The “Hangar Bicocca Foundation” is currently being formed to meet the principles and legal pat-tern of a partner foundation, with the aim of spreading the expressions of contemporary culture,with special reference to art.

Very active in the world of art, it is almost a decade since Pirelli agreed to provide corporate sup-port to the Brera Art Gallery, the city of Milan’s most ancient art collections and one of the mostimportant in Europe.

This agreement envisages Pirelli’s active collaboration with the Art Gallery to gradually renovate16th century Veneto paintings that are displayed in the 14th Hall. After Giovan Gerolamo Savoldo’s“Pala Pesaro”, whose restoration was completed in 2005, 2006 witnessed the commencement ofrestoration works on Jacopo Palma il Vecchio’s gigantic “Adoration of the Magi”.

An example of a highly absorbing collaboration between partners, Pirelli’s support for the ArtGallery has led to the design and creation of an innovative and rather unique machinery designedby architect Sottsass to perform renovation works in full view of the public, without concealingpaintings from visitors.

Pirelli has also agreed on Company’s cooperation with another great player on the Milanese cul-tural scene by recently becoming one of its “corporate members” – it is now an official supporterof the Poldi Pezzoli Museum. Today the Company actively participates in the museum’s initia-tives, sharing its guidelines and strategies.

C U L T U R E & T R A I N I N G

An initiative entirely promoted and organised by Pirelli is the “Pirelli International Award”,which is, by now, extensively consolidated. Since 1996 it has been an important multimediacompetition to spread scientific culture. It is entirely organised over the Web. Every year theprize is assigned to the best multimedia presentation in the field of physics, chemistry,mathematics, biology, information technology and communication.

In 2006 Pirelli participated in the exhibition “Science, City and Life” organised by theUniversità di Bicocca to celebrate one hundred years of the Sempione Universal Exhibition thatwas held in Milan in 1906. Pirelli was a protagonist at the event, featuring as an exemplary com-pany for the remarkable Italian industrial development of the time. In fact, Pirelli has always beena landmark for corporate culture and, its over 130 years are doubtless a heritage of historical inter-est. Pirelli also preserves and optimises its corporate culture as a founding member of the Webportal www.archiviefuturo.it, which is dedicated to the history of leading Italian companies.

298


RESTORERS IN THE BRERA

ART GALLERY

Pirelli’s partnership with Fondazione Silvio Tronchetti Provera looks, instead, to the futureby promoting research in economics, science, technology and management, besides talent devel-opment in these sectors. It allocates funds, prizes, study grants and contributions for the equip-ment of universities and scientific institutions. The activity is conducted either directly or in col-laboration with other individuals, especially making use of the partnership with the three Milaneseuniversities – Milan Polytechnic, Università Commerciale Luigi Bocconi and Università degli Studidi Milano Bicocca, whose rectors are members of the Foundation’s Board of Directors.

On the other hand, scientific and technological culture is the very core of Group actions; hencethe need to mention an initiative promoted by Fondazione Silvio Tronchetti Provera along withFondazione Veronesi and Fondazione Cini – “The Future of Sciences”. This cycle of confer-ences and debates on scientific topics witnessed the participation of many Nobel prize winnersand internationally famous scientists and researchers. The three-day initiative, which has nowbeen organised for the second time, is held at the Cini Foundation on the island of San GiorgioMaggiore in Venice.

Pirelli has long partnered the FAI – Fondo per l’Ambiente Italiano, in various initiatives, num-bering also the organisation of courses on history of art for the extensive public. The two–yearperiod 2005/2006 witnessed Pirelli and FAI committed – with the patronage of the LombardyRegional Administration, the Lombardy Provincial Administration and the Milan Municipality – ina new edition of “ Lunedì dell’Arte, a cycle of lessons held at the University of Milan by the mostfamous experts in the sector. They retraced and illustrated the works and experiences of interna-tional contemporary art.

Training plays a crucial role in a company’s real estate sector. As process and product innovator,it is in line with Pirelli RE’s “positioning responsibilities” and mission to encourage improvementsin the sector’s professional standards. The quest for professional excellence and training profes-sionals to face the “new way” of conducting real estate business in an Anglo-Saxon style are per-fectly summarised in the Master in Real Estate, a postgraduate qualification designed, promot-ed and implemented in association with two of the most prestigious Italian universities – theBocconi and the Milan Polytechnic. They both provide the skills required by current real estateprofessionals – finance, technical aspects, economics, architecture, business planning and townplanning. The first year over 30 students participated in the Master (but applications were threetimes this number); they were immediately employed in high quality professional outlets;

299


THE 15th COLEÇAO PIRELLI

HELD AT THE MASP

S P O R T

Pirelli has always been involved in sports, not only in motoring competitions on either two or fourwheels. The Group’s other choice sports are historically also football – it sponsors FCInternazionale in Italy, Palmeiras in Brazil, Peñarol in Uruguay and Basel in Switzerland – and sail-ing – it yearly organises the Pirelli Coppa Carlo Negri Regattas in the waters of Santa Margherita.

But the Group’s commitment to sports is not limited to participation in the highest professionalstandards. Quite the reverse; Pirelli is involved in the extensive promotion of a sports-oriented cul-ture to spread social life based on values of solidarity and ethical conduct, even among theyoungest.

In the field of “solidarity sailing”, Pirelli created the initiative “Matti per la Vela” (Crazy about sail-ing). A group of healthcare professionals, voluntary workers and professional skippers with a pas-sion for sailing designed the project in Genoa in 1998 to use sailing as a therapeutic tool to helpand recover people who suffer from various psychic diseases and disorders.

Lastly, Pirelli has organised the “Derby del Cuore” for over ten years. Every summer famous fig-ures from the show biz and sports world and Inter and Milan fans challenge each other before thetypical audience of great occasions in a football game, whose profits are assigned to charity.

F O C U S O N L A T I N A M E R I C A

As described for activities targeted at the internal community, even concerning those for the exter-nal community,, this year’s social report will concentrate on Latin America where the Group’smany frameworks perform a wide range of actions to both involve and sustain local communities.

Starting with kids, “The Kid Project” in Brazil is a governmental project to encourage the socialand cultural integration of young Brazilian citizens aged between 8 and 18 years. Implemented in1995, the project focuses on teaching music in 375 centres, many of which are sponsored by lead-ing companies present in the country. The overall project today involves over 48,000 youth. Pirelliruns the Santo André Centre.

The Group’s cultural activities in Brazil are many and highly differentiated. Pirelli, in fact, partnersthe MAM – San Paolo Museum of Modern Art, the oldest and one of the most important muse-ums of modern art in the continent. This sponsorship encourages the development of museumactivities, also numbering cultural events, workshops and courses. Pirelli’s sponsorship of theMAM also ensures employees and their relations a free visit to the exhibition.

Always in San Paolo, the famous MASP – Museu de Arte de São Paulo hosts “Coleçao Pirelli”with approximately 900 works portraying the many aspects of Brazilians’ daily life photographedby over 200 leading photographers in the country over the past fifteen years. In fact, 2006 celebrat-ed both the collection’s 15th anniversary and such a close and significant partnership. Focus onlocal communities’ social life was finally confirmed by Pirelli’s participation in the cultural proj-ect “Projeto café”, twelve monthly instalments annexed to the bilingual magazine “PanoramaRural” on coffee’s three hundred-year history in Brazil. It highlights the social responsibility andrelated commitments of international companies operating in the global markets to the advantageof local communities, even by investing in educational, environmental and cultural projects toestablish a sustainable development model.

Concerning training, Pirelli has undersigned an agreement in Venezuela to implement the “CentroTecnológico y Conocimiento del Caucho Pirelli”, a corporate unit created to offer theCompany services on the use of new technologies in training human capital. The project is alsotargeted at suppliers, clients and especially employees’ families.

300


In Argentina Pirelli has started a cooperative project with two technical institutes nearMerlo to enable students to integrate educational training and factory work in order to build expe-rience and expertise directly in the work framework. Students who have worked for Pirelli for twoyears are anyhow paid for their services.

But in countries where economic embarrassment and a precarious lifestyle primarily concern chil-dren, the passion for sports becomes a very precious aid for solidarity and educational pro-grammes. Of all sports, football’s popularity is unrivalled. Hence, following the model of InterCampuses opened in Italy, when the team’s ambassador was Ronaldo, Pirelli and Inter started theproject “Inter Pirelli Campus Brazil” in San Paolo, Brazil, in 1997. Their goal was to offeryouth aged from 8 to 14 the opportunity of leaving the alleys of the favelas, while facilitating socialintegration by associating school attendance with the opportunity to cultivate the passion for foot-ball.

The Brazilian initiative’s success (i.e. over four thousand children are yearly won over to schools)led FC Internazionale to organise similar programmes in other “risk” areas in the world. Today 20countries in the four continents host these “solidarity football” projects.

301


AN INTER PIRELLI CAMPUS

IN BRAZIL

R E L A T I O N S W I T H P U B L I C A D M I N I S T R A T I O N S

Group companies maintain relationships with local, national and supranational authoritiesin a spirit of full and active cooperation and transparency that does not compromise theirindependence, economic targets or the values enshrined in this Code (Article 5 of the EthicalCode – Community).

Group companies are represented in national and super-national institutions in the framework ofrelations with Public Administrations (i.e. Governments, Parliaments, Public Institutions, centraland local administrations, both Italian and foreign).

The dialogue on which relations with Public Administrations are based is conducted believing thatbusiness and relational ethics must be pursued along with the Company’s success.

In 2006 Relations with Institutions actively concerned both the countries where the Pirelli Group’spresence has long been consolidated and those where the Group’s presence is more recent, suchas. Romania and China.

In particular, in these two cases Relations with Institutions basically concerned Pirelli’s integra-tion in the local system from an industrial and social perspective (i.e. investments to open newproduction sites, professional integration/training programmes for human resources), alwaysrespecting the country’s cultural specific features.

Pirelli’s actions in the framework of Relations with Public Administrations number defining/mon-itoring modes and procedures envisaged by the specific reference regulations to obtain and man-age information, contributions, grants and funds from national/foreign public bodies for invest-ment, scientific and technological research and, social and economic projects (training pro-grammes, upgrading programmes, etc). During the entire procedure, relations with PA are basedon the utmost transparency and truthfulness of the information conveyed (i.e. from defining fund-ing sources to checks and inspections conducted by the funding institution), thus avoiding tech-nical and financial assessment errors, trends unduly directed to the advantage of Group interestsand conflicts of interest.

Concerning systems adopted to further enhance the Company’s internal control, the Group’sItalian Affiliates have long adopted an organisational model geared towards perfecting a systemthat is modulated by specific requirements envisaged by the local legislation (Legislative Decreen° 231/2001) concerning companies’ administrative responsibility in crimes committed by theiremployees to the advantage of the said companies. A special Supervisory Body that is envisagedin each Group’s Italian Affiliate has been assigned the task of monitoring both the organisationalmodel’s correct function and the internal behaviours’ compliance with the same.

In 2006 the Organisational Model was also reviewed to align it with the developments ofRegulation n° 231.

To build further opportunities to improve the internal control system, other Group companies tooadopted some control activities envisaged in Italian companies’ Organisational Models, which aresuitable to reasonably prevent the risk of crime, by issuing specific policies and operational rules.

In 2006 the Internal Audit Department carried out 60 auditing interventions in the Group’s frame-work; 18 of these were carried out following a mandate issued by the Italian Companies’Supervisory Bodies. The audits were aimed at verifying the extent of compliance of companyprocesses with the internal control procedures set down by the Organisational Model adopted.

302


G R I ( G L O B A L R E P O R T I N G I N I T I A T I V E ) TA B L E O F C O N T E N T S

This section is designed to enable readers to relate topics discussed in the report to the interna-tional experience of the GRI and the Global Compact.

REPORTING ELEMENTSReporting Pageelements

Strategy and Analysis 1.1 8 Organisational Profile 2.1-2.10 11-94, 224 Report Parameters Report Profile 3.1-3.4 60-94

Report Goals and Limits 3.5-3.8 209GRI Table of Contents 3.12 303

Governance, Tasks andCommitments Corporate Governance 4.1-4.8 60-94

Commitments for the External Community 4.12 213-216 Stakeholder Commitments 4.14-4.16 209, 221-228, 282

PERFORMANCE INDICATORS Area Aspect Indicators Page

Environmental Economic Performance EC1 218-219 Economics Energy EN3-6 243-246, 249-251

Water EN8, EN10 243-246, 249-251 Biodiversity EN11-13 231-232 Emissions, Outflow and Waste EN16-24 232, 243-246, 249-251Products and Services EN26 237, 241, 254-264 Compliance EN28 231

Work Procedures Employment LA1-2 267-268 Industrial Relations LA4 284 Health and Safety LA7-8 285-288 Training LA10-12 273-278 Diversity and Equal Opportunities LA13-14 3, 271

Human Rights Purchase Procedures HR1-2 226 Non Discrimination HR4 271 Free Association and Collective Contracts HR5 212, 284 Child Labour HR6 212, 258 Forced or Compulsory Labour HR7 212 Safety Procedures HR8 273-274

Companies Communities SO1 243-266, 295-301Corruption SO2-4 302Political Contributions SO5-6 219Compliance SO8 286

Product Responsibility Consumer Safety and Health PR1 225, 241 Product labelling and Services PR5 223

303


G L O B A L C O M P A C T P R I N C I P L E S A N D G R I I N D I C A T O R S

Global Compact Global Compact Principles Directly IndirectlyAreas relevant relevat

GRI indicators GRI indicatorsHuman rights Principle 1 – Companies are requested to HR 1-9 LA 4, LA13-14, SO1

promote and respect globally recognised human rights in their respective influence frameworks; and,Principle 2 – To ensure that they are not HR1-2, HR8indirect accomplices in the violation ofhuman rights.

Labour Principle 3 – Companies are requested to support HR5, LA4-5the free association of workers and to acknowledge the right to collective contracts; Principle 4 – Remove all forms of either forced HR7 HR1-3or compulsory labour; Principle 5 – Effectively remove HR6 HR1-3child labour; and, Principle 6 – Remove all forms of HR4, LA2, LA13, HR1-2, EC5, EC7,employment and professional discrimination. LA14 LA 3

Environment Principle 7 – Companies are requested to Profile disclosure 4.11 EC2follow a preventive approach towardsenvironmental challenges; Principle 8 – Undertake initiatives that EN2, EN 5-7, EN10, EC2, EN1, EN3-4,promote greater environmental EN13-14, EN18, EN8-9, EN11-12,responsibility; EN21-22, EN26-27, EN15-17, EN19-20,and, EN30 EN23-25, EN28-29,

PR3-4 Principle 9 – Encourage the development and EN2, EN5-7, EN10, EN26-27widespread use of environment-friendly EN18, technologies.

Combat corruption Principle 10 – Companies undertake to SO2-4 SO5-6fight all forms of corruption,including extortion and bribes.

304


305


GLOSSARYA damaging event caused by a violent occurrence during the performance of an employee’s work duties, and which leads to death or a permanent inability (total or partial) to perform these duties, or a temporary inability requiring absence from work.

Business to Business: the relationship that a company entertains with its suppliers or with its professional clients.

Machinery for preparing polymer blends, which are used as the raw material for producing plastic- or rubber-based components. The ingredients are put into the Banbury according to their various specified quantities and times, then mixed at a determined temperature and pressure until they form a blend, which is then extruded in granules or strips.

These are practices that the company follows to analyse and measure the organisational processes, policies and indicators of its quality of service.

Basic element used to make up the resistant structure of the tyre carcass.

Colourless and odourless, carbon dioxide is a naturally-occurring component of the Earth’s atmosphere. It is one of the compounds produced during combustion of materials containing carbon, and it contributes to the greenhouse effect (see separate entry).

The name of a course aimed at developing managers’ skills in managing their staff by means of getting feedback on their work and then coaching them (i.e. providing assistance and support) to help them identify the resources they need to reach their objectives.

Part of the global system of management that facilitates management of health and safety risks in the workplace thatare connected with company activities. It includes the organisational structure, planning activities, responsibility,practices, procedures, processes and resources for developing, putting into place, implementing, re-examining andmaintaining the workplace health and safety policy.

An interactive system involving an interviewer and a computer, based on the use of a software package developed fordata collection. The questionnaire resides on a computer and the questions are displayed on the video screen.

System for extracting and recovering the heat from the air in the environments.

The voluntary acknowledgement of social and ecological concerns by a company in its commercial operations and inits relations with the parties concerned.

Defined as the set of activities implemented by a company to build and communicate its identity to a target thatincludes both candidates and employees, so that the company (as brand) will attract and retain persons who fit in withthe company’s culture and values.

A systematic survey of the environmental conditions on a site in order to establish its current or potentialenvironmental liabilities.

Any change to the environment, detrimental or beneficial, total or partial, as a consequence of an organisation’sactivities, products or services.

Numeric parameter or value that describes the impact of a human activity on the environment.

Part of the overall system of management that includes the organisational structure, planning activities, responsibility,practices, procedures, processes and resources for developing, putting into place, implementing, re-examining andmaintaining the environmental policy.

A process of assembling blends to make semifinished products, via specific fusion processes on those blends.

A method of accounting for part-time employees. The work hours of part-time employees are expressed taking thework hours of a full-time employee as a base. So a full-time employee is 1 FTE, and a part-time worker who works 50%counts as 0.5 FTE. For example, two part-time 50% workers (FTE=0.5) equal one full-time worker (FTE= 0.5 x 2 = 1).

Electrochemical devices that convert chemical energy to electrical energy. They are classed according to the electrolyteused in the process. Various different fuels can be used (natural gas, hydrogen etc.).

Accident

B2B

Banbury

Best Practices

Body-ply

Carbon dioxide (CO2)

Coaching & Feedback

Company Health and SafetyManagement System

Computer-aided telephoneinterviews (CATI)

Controlled ventilation system

Corporate SocialResponsibility(CSR)

Employer Branding

Environmental Due Diligence

Environmental impact

Environmental indicator

Environmental ManagementSystem

Extrusion

FTE (Full-TimeEquivalent)

Fuel cells

306


Global Reporting Initiative(GRI)

Greenhouse effect

Grooves

Hazardous waste

Heat value

Intermediate energy sources

ISO 14001

IT systems

Job meeting

Job rotation

Kyoto Protocol

Life Cycle Assessment (LCA)

LPG

MBO

Nanocomposite

Nanomaterials

Nanotechnology

Newton

NGO

Nitrogen oxides

Non-hazardous waste

The Global Reporting Initiative is an international programme for the global development and dissemination ofguidelines for reporting on sustainability. The promoters of GRI are CERES (Coalition for Environment ResponsibleEconomies) and UNEP (United Nation Environmental Programme).

An increase in the Earth’s temperature due to the excessive presence of certain gases (mainly carbon dioxide, someoxides of nitrogen and ozone) which do not allow heat to dissipate.

Shallow engravings on the tread (the surface of a tyre that comes into contact with the road), generally indented and/orfinely subdivided. The function of the grooves is to improve the road-holding and adherence of the tyre, especially onsmooth or wet road surfaces.

Categories of waste that present substantial or potential danger to human health or to the environment, classifiedaccording to European legislation (see also non-hazardous waste).

Quantity of thermal energy (heat) released by a determined mass of fuel burning under standard conditions. Adistinction is made between Gross Heat Value (GHV), which represents all the thermal energy developed duringburning, and Net Heat Value (NHV), which represents the difference between the total heat released and the heat lostdue to evaporation of the water produced during combustion. Heat value is normally expressed in joules perkilogramme (J/kg) or kilocalories per kilogramme (Kcal/kg) for solid and liquid fuels, and in joules per cubic metre(J/m?) or kilocalories per cubic metre (Kcal/m?) for gaseous fuels.

Forms of energy produced by converting primary energy into other forms. The two most common examples areelectricity and steam.

A standard, issued by the ISO (International Organisation for Standardization), specifying the requirements of anEnvironmental Management System that enables an organisation to formulate an environmental policy and establishobjectives, taking account of legislation and information on significant environmental impacts.

Information technology systems.

A work orientation meeting.

Rotation of work duties. A number of workers are periodically assigned to different areas of the company, and thisrotation of workers between different jobs creates a group of employees who have a knowledge of all the differentphases of the production process and who also have a global view of the problems that can arise in the workenvironment, both in terms of production and in terms of human relations.

An international agreement to reduce atmospheric emissions of gases that cause the greenhouse effect (see separateentry), which is responsible for global warming.

A method of calculating the overall environmental impact of a product, by taking account of its entire life cycle,starting from the extraction and processing of the raw materials and including the processes involved in itsmanufacture, transport, distribution, use, recycling/reuse and finally disposal.

Liquid Propane Gas.

Management By Objectives: a system of annual incentives based on objectives defined at the start of the year.

A blend of materials (ceramics, metals etc.) with dimensions in the order of nanometres.

Materials with dimensions in the order of nanometres (10-9 m).

Technology for developing nanomaterial-based applications.

Unit of measurement of force (abbreviated to N) in the International System. One Newton is equal to the forcenecessary to impart an acceleration of 1 m/s2 on a mass of 1kg.

Non-Governmental Organisation.

Gases produced by the combustion of fossil fuels. These gases contribute to the formation of ozone in the loweratmosphere and to ‘acid’ deposits during ordinary rainfall.

Categories of waste that present no danger to human health or to the environment, classified according to EuropeanCommunity Directive 2000/532, modified by Directives 2001/118/EC, 2001/119/EC and 2001/573/EC.

See nitrogen oxides.

Organization for Economic Co-operation and Development.

International certification standard for safety in the workplace and industrial hygiene. The standard gives therequirements for a Health and Safety Management System in the workplace, enabling a company to manage its risks inthis area and improve its performance.

Any VOC (see separate entry) used on its own or in combination with other agents to dissolve raw materials, productsor waste material without undergoing chemical transformations, or used as a cleaning agent to dissolve contaminants,or as a dissolving agent, means of dispersion, viscosity correction agent, surface tension correction agent, plasticizingagent or preservative.

Allotropic form of oxygen with the chemical formula O3. Ozone is found in minimal quantities in the air and it is formedby electrical discharges and ultraviolet rays, which convert oxygen molecules to ozone. Approximately 25km from theEarth’s surface there is a concentrated layer of ozone that absorbs ultraviolet rays and essentially protects life on theplanet; it is known as the ozonosphere. The reduction in the thickness of the ozone layer in the atmosphere (commonlyknown as ‘the hole in the ozone layer’) seems to be linked to activities of human origin and resulting in the release ofnitrogen oxides (see separate entry) and chlorofluorocarbons (see separate entry) into the atmosphere.

Unit of measurement of pressure in the International System. One Pascal is equal to 1 Newton per square metre (Pa =N/m?).

Acronym for polychlorinated biphenyls/polychlorinated triphenyls. These substances are potentially extremelydangerous and can be bioaccumulated. They have insulating properties and are fire-resistant, and are mainly used inelectrical devices, e.g. capacitors and transformers (see separate entry).

A type of atmospheric pollution mainly caused by gaseous emissions from urban vehicular traffic. It is the result of acomplex chain of photochemical oxidation reactions, i.e. reactions resulting from sunlight and favoured by specificmeteorological conditions (e.g. a temperature inversion). One of the consequences of photochemical smog is that itincreases the concentration of ozone in the troposphere (see separate entry), which then becomes a secondarypollutant. In addition, the low-volatility organic compounds that form can condense, forming a mist of microscopicglobules.

The science and technology of a class of devices that use photons. The term ‘photonics’ was invented by analogy with‘electronics’: instead of electrons, photons are used in operations that we normally associate with informationprocessing, transmission and storage.

A physical quantity expressing the relationship between the intensity of a force (expressed in Newtons) applied to asurface perpendicular to it, and the area of the surface (expressed in square metres).

Energy sources consumed to provide final energy services (e.g. heating, transport) or to produce intermediate forms ofenergy like electricity or steam. Examples of primary energy sources are: coal, natural gas, liquid propane gas, fuel oil,and biomass.

The point of reference and person responsible for a process.

The component of a vehicle’s resistance to movement which is ascribed to the tyre alone.

International standard issued by the CEPAA (Council of Economical Priorities Accreditation Agency) on respect forhuman rights, respect for workers’ rights, protection against the exploitation of minors, and standards of safety andproper conduct in the workplace.

“Holders of legitimate interests” in the company, i.e. parties (individuals or groups) who have an interest in thecompany’s decisions, influence its success and/or are influenced by the organisation’s activities.

A document that illustrates a task and the requirements for performing it.

The committee responsible for evaluating, directing and coordinating all activities of the Group that come under theheading of Corporate Social Responsibility. It includes managers from the following departments: Administration &Control Department, Public and Economic Affairs Department, Personnel Department, Health, Safety and EnvironmentDepartment (this last department is also the Committee Secretariat).

Mechanical process of assembling brass-coated wires.

307


NOX

OECD

OHSAS 18001

Organic solvent

Ozone

Pascal

PCB/PCT

Photochemical smog

Photonics

Pressure

Primary energy sources

Process owner

Rolling resistance

SA 8000

Stakeholder

Standard Positions

Steering Committee CSR(Corporate Social

Responsibility)

Stranding

See Sustainable development.

An investment bond rating based on criteria regarding the sustainable performance of the company being evaluated.The rating is issued by an independent third party.

Development that meets the needs of the current generation without compromising the capacity of future generationsto meet theirs. This type of development is not a pre-set harmonious state, but rather a process of change in which theuse of resources, management of investments and institutional change are made compatible with future needs as wellas with current needs.

Tonne of oil equivalent: a unit of energy that expresses the thermal energy that can be obtained from fuels other thanoil, taking oil as a base. The conversion factors adopted by the Group are as follows:1 toe = 41.86 GJElectricity: 1 kWh = 860 Kcal = 0.000086 toeFuel oil: 1 toe = 0.98 tepDiesel: 1 toe = 1.08 tepLPG: 1 toe = 1.10 tepNatural gas: 1000 m? = 0.82 toe

A static (i.e. with no moving parts) electrical apparatus that transfers electricity from one circuit (primary) to another(secondary) and changes the voltage and current. In its simplest form, a transformer comprises a closed magneticcircuit, made with silicon iron core lamination, and two reels obtained by helically winding two conductors on aninsulating base.

A physical phenomenon that allows the conduction of heat from outside the environment to inside and vice-versa viacontact with a vertical barrier.

The lowest layer of the atmosphere, extending from the Earth’s surface to the stratosphere. The troposphere is wherethe most common meteorological phenomena occur.

Any organic compound – of natural or artificial origin – which has a vapour tension of 10 Pascals or higher at atemperature of 20°C, or which has a corresponding volatility under particular conditions of use. VOCs can contribute tothe production of photochemical smog (see separate entry), with consequent impacts on health and the environment.

308


Sustainability

Sustainability rating

Sustainable development

toe

Transformer

Transmittance

Troposphere

Volatile Organic Compounds(VOCs)

309

Graphic project CRM S.r.l. - www.crm.itPrinting Lucini, Milan - www.lucinisrl.com

Printed on recycled paper

310